** **

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

** **

**FORM 10-Q/A**

**(AmendmentNo. 1)**

 

**(Markone)**

 
| **ý** | ** ** | **QUARTERLY REPORT UNDER SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|------------|--------------------------------------------------------------------------------------------------|

 

**Forthe quarterly period ended October 2, 2005**

 
| **o** | **TRANSITION REPORT UNDER SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|---------------------------------------------------------------------------------------------------|

 

**For the transition period from                   to                   .**

 

**Commissionfile number:  000-51348**

** **

**ev3 Inc.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                    | ** ** |                                 |
|---------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of |       | **32-0138874**                       |
| incorporation or organization)  |       | (IRS Employer Identification Number) |

 

**9600 54****th****AvenueNorth, Suite 100Plymouth, Minnesota 55442**

(Address of principal executiveoffices)

 

**(763) 398-7000**

(Registrant’s telephone numberincluding area code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days. YES  ý  NO  o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).  YES  o  NO  ý

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  YES  o  NO  ý

 

As of November 1, 2005, there were 49,155,616shares of common stock, par value $0.01 per share, of the registrantoutstanding.

 

 

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**ev3Inc.**

**FORM 10-Q**

**Forthe Quarterly Period Ended October 2, 2005**

** **

EXPLANATORY NOTE

 

The purpose of thisAmendment No. 1 on Form 10-Q/A (the “Form 10-Q/A”) to theQuarterly Report on Form 10-Q for the quarter ended October 2, 2005(the “Original Form 10-Q”) of **ev3**Inc. (the “Company”) is to restate the Company’s consolidated statement of cashflows for the nine months ended October 2, 2005 included in the Original Form 10-Q,as filed with the Securities and Exchange Commission (the “SEC”) on November 16,2005 (the “Original Filing Date”).  On February 20,2006, the Company’s management and Audit Committee of the Board of Directorsdetermined that the Company’s consolidated statement of cash flows for the ninemonths ended October 2, 2005 required restatement to correct an error in the classification of a $36.5million payment by the Company of accrued interest on the Company’s demandnotes payable made in conjunction with the completion of the Company’s initialpublic offering on June 21, 2005. The interest payment was reported as a cash out-flow under “financingactivities” and should have been reported as a cash out-flow under “operatingactivities” under generally accepted accounting principles.  The restatement does not affectthe net change in cash for the nine months ended October 2, 2005 and hasno impact on the Company’s consolidated balance sheet as of October 2,2005, the consolidated statement of operations and related net loss per common shareattributable to common stockholders for the three and nine monthsended October 2, 2005 orthe reported changes in stockholders’ equity (deficit) for the three and ninemonths ended October 2, 2005. See Note 2 in the notes to the consolidatedfinancial statements for further information relating to the restatement.

 

For the convenience ofthe reader, this Form 10-Q/A sets forth the Original Form 10-Q in itsentirety.  However, this Form 10-Q/Aonly amends and restates Items 1, 2 and 4 of Part I of the Original Form 10-Q,in each case solely as a result of, and to reflect the restatement, and noother information in the Original Form 10-Q is amended hereby.  Except for the restatement, the foregoingitems have not been updated to reflect other events occurring after theOriginal Filing Date or to modify or update those disclosures affected bysubsequent events.  In addition, pursuantto the rules of the SEC, Item 6 of Part II of the Original Form 10-Qhas been amended to contain currently-dated certifications from the Company’sChief Executive Officer and Chief Financial Officer, as required by Sections302 and 906 of the Sarbanes-Oxley Act of 2002. The certifications of the Company’s Chief Executive Officer and ChiefFinancial Officer are attached to this Form 10-Q/A as Exhibits 31.01,31.02, 32.01 and 32.02.

 

Except for the foregoingamended information, this Form 10-Q/A continues to speak as of theOriginal Filing Date, and the Company has not updated the disclosure containedherein to reflect events that occurred at a later date.  Other events occurring after the filing ofthe Original Form 10-Q or other disclosures necessary to reflectsubsequent events will be addressed in any reports filed with the SECsubsequent to the date of this filing. Concurrently with the filing of this Form 10-Q/A, the Company isfiling Amendment No. 1 on Form 10-Q/A to its Quarterly Report on Form 10-Qfor the quarter ended July 3, 2005.

 

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**TABLEOF CONTENTS**

 
| **Description**    | ** **                                                                                                                                   | ** ** | ** ** |
|--------------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|
|               |                                                                                                                                         |       |
| PART I.       | FINANCIAL INFORMATION                                                                                                                        | ** ** |
|               |                                                                                                                                         |       |
| ITEM 1.            | Financial Statements                                                                                                                         |       |
|               |                                                                                                                                         |       |
|               | Consolidated  Balance Sheets as of October 2, 2005 (unaudited) and December 31,  2004                                              |       |
|               |                                                                                                                                         |       |
|               | Consolidated  Statements of Operations for the three months and nine months ended October 2,  2005 and October 3, 2004 (unaudited) |       |
|               |                                                                                                                                         |       |
|               | Consolidated  Statements of Cash Flows for the nine months ended October 2, 2005 and October 3,  2004 (unaudited)                  |       |
|               |                                                                                                                                         |       |
|               | Notes  to the Consolidated Financial Statements                                                                                              |       |
|               |                                                                                                                                         |       |
| ITEM 2.            | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                                                  |       |
|               |                                                                                                                                         |       |
| ITEM 3.            | Quantitative and Qualitative Disclosures About Market Risk                                                                                   |       |
|               |                                                                                                                                         |       |
| ITEM 4.            | Controls and Procedures                                                                                                                      |       |
|               |                                                                                                                                         |       |
| PART II.      | OTHER  INFORMATION                                                                                                                           | ** ** |
|               |                                                                                                                                         |       |
| ITEM 1.            | Legal Proceedings                                                                                                                            |       |
|               |                                                                                                                                         |       |
| ITEM 2.            | Unregistered Sales of Equity Securities and Use of  Proceeds                                                                                 |       |
|               |                                                                                                                                         |       |
| ITEM 3.            | Defaults Upon Senior Securities                                                                                                              |       |
|               |                                                                                                                                         |       |
| ITEM 4             | Submission of Matters to a Vote of Security Holders                                                                                          |       |
|               |                                                                                                                                         |       |
| ITEM 5.            | Other Information                                                                                                                            |       |
|               |                                                                                                                                         |       |
| ITEM 6.            | Exhibits                                                                                                                                     |       |
|               |                                                                                                                                         |       |
| SIGNATURE PAGE     |                                                                                                                                         |
|               |                                                                                                                                         |       |
| Exhibit Index |                                                                                                                                         |       |

 

*In this report, references to “ev3,”“the company,” “we,” “our” or “us,” unless the context otherwise requires,refer to ev3 Inc. and its subsidiaries.*

 

*All trademarks or trade namesreferred to in this report are the property of their respective owners.*

 

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**PART I:****   FINANCIAL INFORMATION**

**ITEM I:****       FINANCIAL STATEMENTS**

 

**ev3 Inc.**

**CONSOLIDATEDBALANCE SHEETS**

*(Dollarsin thousands, except per share amounts)*

*(unaudited)*

 
| ** **                                                                                                                                            | ** ** | **October 2,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                            |       |                      |       |                        |       |
| ***Current assets***                                                                                                                                  |       |                      |       |                        |       |
| Cash and cash  equivalents                                                                                                                            |       | $                         | 94,762     |                        | $          | 20,131 |   |
| Short-term  investments                                                                                                                               |       | 12,010                    |       | —                      |       |
| Accounts  receivable, less allowance of $3,342 and $2,694, respectively                                                                               |       | 23,132                    |       | 18,956                      |       |
| Inventories                                                                                                                                           |       | 31,911                    |       | 22,500                      |       |
| Prepaid expenses  and other assets                                                                                                                    |       | 5,784                     |       | 4,576                       |       |
| Other  receivables                                                                                                                                    |       | 949                       |       | 2,446                       |       |
| *Total current assets*                                                                                                                                |       | 168,548                   |       | 68,609                      |       |
|                                                                                                                                                  |       |                      |       |                        |       |
| Restricted cash                                                                                                                                       |       | 3,363                     |       | 2,638                       |       |
| Property and  equipment, net                                                                                                                          |       | 15,816                    |       | 9,130                       |       |
| Goodwill                                                                                                                                              |       | 94,456                    |       | 94,514                      |       |
| Other intangible  assets, net                                                                                                                         |       | 28,511                    |       | 31,851                      |       |
| Other assets                                                                                                                                          |       | 3,860                     |       | 5,304                       |       |
| *Total assets*                                                                                                                                        |       | $                         | 314,554    |                        | $          | 212,046 |   |
|                                                                                                                                                  |       |                      |       |                        |       |
| **Liabilities  and stockholders’ equity (deficit)**                                                                                              |       |                      |       |                        |       |
| ***Current liabilities***                                                                                                                             |       |                      |       |                        |       |
| Accounts payable                                                                                                                                      |       | $                         | 10,967     |                        | $          | 8,931 |   |
| Accrued  compensation and benefits                                                                                                                    |       | 12,922                    |       | 9,523                       |       |
| Accrued  liabilities                                                                                                                                  |       | 12,110                    |       | 13,821                      |       |
| Accrued  acquisition consideration                                                                                                                    |       | —                    |       | 3,750                       |       |
| *Total current liabilities*                                                                                                                           |       | 35,999                    |       | 36,025                      |       |
|                                                                                                                                                  |       |                      |       |                        |       |
| Demand notes  payable-related parties                                                                                                                 |       | —                    |       | 299,453                     |       |
| Other long-term  liabilities                                                                                                                          |       | 482                       |       | 702                         |       |
| *Total liabilities*                                                                                                                                   |       | 36,481                    |       | 336,180                     |       |
|                                                                                                                                                  |       |                      |       |                        |       |
| Commitments and  contingencies                                                                                                                        |       | —                    |       | —                      |       |
|                                                                                                                                                  |       |                      |       |                        |       |
| Class A preferred membership units: stated  value $3.56; 24,040,718 units authorized; issued and outstanding: zero and  24,040,718, respectively |       | —                    |       | 95,105                      |       |
| Class B preferred membership units: stated  value $3.56; 41,077,336 units authorized; issued and outstanding: zero and  41,077,336, respectively |       | —                    |       | 158,923                     |       |
|                                                                                                                                                  |       |                      |       |                        |       |
| Minority  interest                                                                                                                                    |       | 13,329                    |       | 16,310                      |       |
|                                                                                                                                                  |       |                      |       |                        |       |
| ***Stockholders’ equity (deficit)***                                                                                                             |       |                      |       |                        |       |
|                                                                                                                                                  |       |                      |       |                        |       |
| Members’ capital                                                                                                                                 |       | —                    |       | 47,927                      |       |
| Common stock: $0.01 par value; 100,000,000 shares  authorized; issued and outstanding: 49,147,954 and zero, respectively                              |       | 491                       |       | —                      |       |
| Additional paid  in capital                                                                                                                           |       | 805,086                   |       | —                      |       |
| Accumulated  deficit                                                                                                                                  |       | (540,663                  | )          | (440,705                    | )          |
| Accumulated  other comprehensive loss                                                                                                                 |       | (170                      | )          | (1,694                      | )          |
| *Total stockholders’ equity  (deficit)*                                                                                                          |       | 264,744                   |       | (394,472                    | )          |
| *Total liabilities and stockholders’  equity (deficit)*                                                                                          |       | $                         | 314,554    |                        | $          | 212,046 |   |

 

*The accompanying notes are anintegral part of these consolidated financial statements.*

 

1

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**ev3 Inc.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

*(Dollarsin thousands, except per share amounts)*

*(unaudited)*

 
| ** **                                                                             | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                             | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** |
| **Net  sales**                                                                         |       | $                         | 33,500     |                      | $          | 19,654 |   | $ | 92,722 |   | $ | 60,803 |   |
|                                                                                   |       |                      |       |                      |       |   |   |   |   |
| **Operating  expenses**                                                                |       |                      |       |                      |       |   |   |   |   |
| Cost of goods sold (a)                                                                 |       | 13,590                    |       | 9,327                     |       | 38,484 |   | 27,484 |   |
| Sales, general and administrative (a)                                                  |       | 30,666                    |       | 24,003                    |       | 94,823 |   | 71,960 |   |
| Research and development (a)                                                           |       | 8,436                     |       | 10,577                    |       | 30,653 |   | 30,320 |   |
| Amortization of intangible assets                                                      |       | 2,674                     |       | 2,438                     |       | 7,877 |   | 7,416 |   |
| (Gain) loss on sale or disposal of assets, net                                         |       | 40                        |       | (14,514                   | )          | 204 |   | (14,495 | ) |
| Acquired in-process research and development                                           |       | —                    |       | —                    |       | 868 |   | — |   |
| Total operating expenses                                                               |       | 55,406                    |       | 31,831                    |       | 172,909 |   | 122,685 |   |
|                                                                                   |       |                      |       |                      |       |   |   |   |   |
| Loss from operations                                                                   |       | (21,906                   | )          | (12,177                   | )          | (80,187 | ) | (61,882 | ) |
|                                                                                   |       |                      |       |                      |       |   |   |   |   |
| **Other  (income) expense**                                                            |       |                      |       |                      |       |   |   |   |   |
| Gain on sale of investments, net                                                       |       | —                    |       | —                    |       | (4,611 | ) | (1,728 | ) |
| Interest (income) expense, net                                                         |       | (953                      | )          | 9,802                     |       | 10,833 |   | 20,415 |   |
| Minority interest in loss of subsidiary                                                |       | (486                      | )          | (6,910                    | )          | (1,212 | ) | (11,982 | ) |
| Other (income) expense, net                                                            |       | (8                        | )          | 213                       |       | 2,912 |   | 319 |   |
| **Loss  before income taxes**                                                          |       | (20,459                   | )          | (15,282                   | )          | (88,109 | ) | (68,906 | ) |
|                                                                                   |       |                      |       |                      |       |   |   |   |   |
| Income tax benefit                                                                     |       | (2                        | )          | —                    |       | (61 | ) | — |   |
| **Net  loss**                                                                          |       | (20,457                   | )          | (15,282                   | )          | (88,048 | ) | (68,906 | ) |
| ** **                                                                             |       |                      |       |                      |       |   |   |   |   |
| Accretion of preferred membership units to  redemption value                           |       | —                    |       | 5,988                     |       | 12,061 |   | 17,792 |   |
| **Net  loss attributable to common stockholders**                                      |       | $                         | (20,457    | )                         | $          | (21,270 | ) | $ | (100,109 | ) | $ | (86,698 | ) |
| Net loss per common share attributable to common  stockholders (basic and diluted) (b) |       | $                         | (0.42      | )                         | $          | (8.35 | ) | $ | (4.99 | ) | $ | (43.07 | ) |
| Weighted average  common shares outstanding (b)                                        |       | 49,099,357                |       | 2,547,809                 |       | 20,069,139 |   | 2,012,829 |   |
|                                                                                   |       |                      |       |                      |       |   |   |   |   |
|                                                                                        |
| (a) Includes  stock based compensation charges of:                                |       |                      |       |                      |       |   |   |   |   |
|                                                                                   |       |                      |       |                      |       |   |   |   |   |
| Cost of goods sold                                                                     |       | $                         | 198        |                      | $          | 45 |   | $ | 445 |   | $ | 143 |   |
| Sales, general and administrative                                                      |       | 859                       |       | 192                       |       | 1,904 |   | 1,565 |   |
| Research and development                                                               |       | 295                       |       | 179                       |       | 729 |   | 577 |   |
|                                                                                   |       | $                         | 1,352      |                      | $          | 416 |   | $ | 3,078 |   | $ | 2,285 |   |

 

(b) Net loss percommon share attributable to common stockholders and the weighted averagecommon shares outstanding reflect the June 21, 2005 1-for-6 reverse stocksplit for all periods presented.

 

*Theaccompanying notes are an integral part of these consolidated financialstatements.*

 

2

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**ev3 Inc.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

*(Dollarsin thousands, except per share amounts)*

*(unaudited)*

 
| ** **                                                                                            | ** ** | **Nine Months Ended**     | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                                            | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** |
| ** **                                                                                            | ** ** | **RESTATED**              | ** ** | ** ** | ** ** |
| **Operating  activities**                                                                             |       |                      |       |   |   |
| Net loss                                                                                              |       | $                         | (88,048    | ) | $ | (68,906 | ) |
| Adjustments to reconcile net loss to net cash used in  operating activities                           |       |                      |       |   |   |
| Depreciation and amortization                                                                         |       | 10,790                    |       | 10,416 |   |
| Provision for bad debts                                                                               |       | 393                       |       | 1,179 |   |
| Provision for inventory obsolescence                                                                  |       | 1,775                     |       | 1,416 |   |
| Acquired in-process research and development                                                          |       | 868                       |       | — |   |
| (Gain) loss on disposal of assets                                                                     |       | 217                       |       | (14,493 | ) |
| Amortization of beneficial conversion feature and non-cash  interest expense                          |       | —                    |       | 6,778 |   |
| Gain on sale of investments                                                                           |       | (4,611                    | )          | (1,728 | ) |
| Stock compensation expense                                                                            |       | 3,078                     |       | 2,285 |   |
| Minority interest in loss of subsidiary                                                               |       | (1,212                    | )          | (11,982 | ) |
| Increase (decrease) in cash resulting from changes  in operating assets and liabilities               |       |                      |       |   |   |
| Accounts receivable                                                                                   |       | (5,854                    | )          | (3,389 | ) |
| Inventories                                                                                           |       | (11,318                   | )          | (7,050 | ) |
| Prepaids and other assets                                                                             |       | 2,474                     |       | (5,424 | ) |
| Accounts payable                                                                                      |       | 3,012                     |       | 389 |   |
| Accrued expenses and other liabilities                                                                |       | 1,984                     |       | 2,710 |   |
| Change in accrued interest on demand notes payable                                                    |       | (24,319                   |  )    | 13,660 |   |
| Net cash used in  operating activities                                                                |       | (110,771                  | )          | (74,139 | ) |
|                                                                                                  |       |                      |       |   |   |
| **Investing  activities**                                                                             | ** ** | ** **                | ** ** | ** ** | ** ** |
| Purchase of short-term  investments                                                                   |       | (12,010                   | )          | — |   |
| Purchase of  property and equipment                                                                   |       | (9,913                    | )          | (2,033 | ) |
| Purchase of  patents and licenses                                                                     |       | (1,150                    | )          | (1,094 | ) |
| Proceeds from  sale of assets                                                                         |       | 8                         |       | 10,278 |   |
| Proceeds from  sale of investments                                                                    |       | 4,611                     |       | 1,728 |   |
| Acquisitions,  net of cash acquired                                                                   |       | (1,626                    | )          | (3,750 | ) |
| Change in  restricted cash                                                                            |       | (527                      | )          | (208 | ) |
| Other                                                                                                 |       | 840                       |       | — |   |
| Net cash (used  in) provided by investing activities                                                  |       | (19,767                   | )          | 4,921 |   |
|                                                                                                  |       |                      |       |   |   |
| **Financing  activities**                                                                             |       |                      |       |   |   |
| Issuance of  demand notes payable                                                                     |       | 49,100                    |       | 59,314 |   |
| Proceeds from  issuance of notes payable, net of costs                                                |       | —                    |       | 21,008 |   |
| Proceeds from  exercise of stock options                                                              |       | 931                       |       | 79 |   |
| Proceeds from  issuance of subsidiary stock to minority shareholders                                  |       | 294                       |       | 178 |   |
| Proceeds from  initial public offering, net                                                           |       | 154,946                   |       | — |   |
| Other                                                                                                 |       | —                    |       | (1,187 | ) |
| Net cash  provided by financing activities                                                            |       | 205,271                   |       | 79,392 |   |
|                                                                                                  |       |                      |       |   |   |
| Effect of  exchange rate changes on cash                                                              |       | (102                      | )          | (75 | ) |
| Net increase in  cash and cash equivalents                                                            |       | 74,631                    |       | 10,099 |   |
| Cash and cash  equivalents, beginning of year                                                         |       | 20,131                    |       | 23,625 |   |
| Cash and cash  equivalents, end of year                                                               |       | $                         | 94,762     |   | $ | 33,724 |   |
|                                                                                                  |       |                      |       |   |   |
| Supplemental disclosure of non-cash activities:                                                       |       |                      |       |   |   |
|                                                                                                  |       |                      |       |   |   |
| Assets acquired in conjunction with MTI step  acquisition (see Note 6)                                |       | $                         | 7,536      |   | $ | — |   |
| Contribution of demand notes payable upon initial  public offering (see Note 12)                      |       | $                         | 324,230    |   | $ | — |   |
| Preferred membership units converted to common stock  upon initial public offering (see Note 13) |       | $                         | 266,089    |   | $ | — |   |

 

*Theaccompanying notes are an integral part of these consolidated financialstatements.*

 

3

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**ev3 Inc.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

*(unaudited)*

 

**1. Description of Business**

 

We area global medical device company focused on catheter-based, or endovascular,technologies for the minimally invasive treatment of vascular diseases anddisorders. We develop, manufacture and market a wide range of products thatincludes stents, embolic protection devices, thrombectomy devices, balloonangioplasty catheters, foreign object retrieval devices, guidewires, emboliccoils, liquid embolics, microcatheters, and occlusion balloon systems. Wemarket our products in the United States, Europe, Canada, and Japan through adirect sales force, and through distributors in certain other internationalmarkets.

 

Wehold ownership interests directly in two companies: ev3 Endovascular, Inc.(“ev3 Endovascular”) and Micro Investment, LLC (“MII”), a holding company thatowns a controlling interest in Micro Therapeutics, Inc. (“MTI”), apublicly traded operating company. Our majority equity holder, Warburg, PincusEquity Partners, L.P. and certain of its affiliates (collectively “WarburgPincus”), owns a majority, controlling interest in us. We are organized in twobusiness segments: cardio peripheral and neurovascular. We manage our businessand reports our operations internally and externally on this basis. Our cardioperipheral segment contains products that are used in both cardiovascular andperipheral vascular procedures by cardiologists, radiologists, vascularsurgeons and other endovascular specialists. Our neurovascular segment containsproducts that are used primarily by neuro-radiologists and neurosurgeons forneurovascular procedures.

 

**2. Basis of Presentation**

 

Theaccompanying unaudited financial statements have been prepared by us inaccordance with accounting principles generally accepted in the United Statesof America (U.S.) for interim financial information and pursuant to theinstructions to Form 10-Q and Article 10 of Regulation S-X of theSecurities and Exchange Commission. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal, recurring adjustments)considered necessary for a fair presentation have been included.  The results for the three and nine monthsended October 2, 2005 are not necessarily indicative of the results thatmay be expected for the year ending December 31, 2005, or for any futureperiod.  These unaudited consolidatedfinancial statements and notes should be read in conjunction with the auditedfinancial statements and the notes thereto included in our registrationstatement on Form S-1, initially filed with the Securities and ExchangeCommission on April 5, 2005 (File No. 333-123851), as subsequentlyamended (the “Registration Statement”).

 

Ourconsolidated financial statements include the financial results of MTI, which weconsolidate for accounting purposes but is not wholly owned.  All significant intercompany accounts andtransactions have been eliminated in consolidation.

 

On May 26,2005, Warburg Pincus and The Vertical Group L.P. and certain of its affiliates(collectively “Vertical”) contributed all of the shares of MTI’s common stockdirectly owned by them to ev3 LLC in exchange for common membership units.These common membership units were subsequently converted into shares of ev3Inc. common stock in connection with a subsequent merger of ev3 LLC with andinto ev3 Inc. on June 21, 2005.  Asa result of this merger, ev3 Inc. became the holding company of ev3 LLC’ssubsidiaries. The merger of ev3 LLC with and into ev3 Inc. was accounted for asa combination under common control with the result that the financialstatements for all periods presented were such that the historical financialstatements of the group were carried forward without adjustment.

 

As thecontrolling shareholder of ev3 LLC, the contribution of the shares by WarburgPincus, representing a 15.7% interest in MTI as of May 26, 2005, wasaccounted for as a transfer of assets between entities under common controlresulting in the retention of historical based accounting. These consolidatedfinancial statements give effect to the contribution of MTI shares owned byWarburg Pincus as though such contribution occurred in 2003 and 2004 whenWarburg Pincus acquired its interest in MTI. The contribution of the MTI sharesowned by Vertical, representing a

 

4

----

 

4.3%interest in MTI as of May 26, 2005, was accounted for under the purchasemethod of accounting on the contribution date (see Note 6).  As of October 2, 2005, ev3 Inc. owned70.2% of the outstanding shares of common stock of MTI.  The consolidation of MTI for accountingpurposes results in all of MTI’s assets and liabilities being included in ourconsolidated balance sheets. Although all of MTI’s assets are included in ourconsolidated balance sheets, not all of these assets would be available to usfor distribution to our stockholders in the event of MTI’s liquidation.

 

Priorto the consummation of our initial public offering on June 21, 2005, weamended and restated our certificate of incorporation to authorize 100,000,000shares of common stock, par value $0.01 per share, and 100,000,000 shares ofpreferred stock, par value $0.01 per share. On June 21, 2005, immediately prior to our initial public offering,we completed a one-for-six reverse stock split of our outstanding commonstock.  All share and per share amountsfor all periods presented in these consolidated financial statements reflect thissplit.

 

Weoperate on a manufacturing calendar with our fiscal year always ending on December 31.  Each quarter is 13 weeks, consisting of onefive-week and two four-week periods. Accordingly, the first three fiscal quarters in 2004 ended on April 4,July 4 and October 3.  Thecorresponding fiscal quarters in 2005 ended on April 3, July 3 and October 2.

 

***Restatement***

 

In the course offinalizing our consolidated financial statements for the fiscal year ended December 31,2005, we determined that our consolidated statement of cash flows for the ninemonths ended October 2, 2005 should be restated to correct an error in theclassification of a $36.5 million payment by us of accrued interest on ourdemand notes payable made in conjunction with the completion of our initialpublic offering on June 21, 2005. The interest payment was reported as a cash out-flow under “financingactivities” and should have been reported as a cash out-flow under “operatingactivities” under generally accepted accounting principles. The restatementdoes not affect the net change in cash for the nine months ended October 2,2005 and has no impact on our consolidated balance sheet as of October 2,2005, the consolidated statement of operations and the related net loss percommon share attributable to common stockholders for the three and nine monthsended October 2, 2005 or the reported changes in stockholders’ equity(deficit) for the three and nine months ended October 2, 2005.

 

A summary of the effectsof the restatement on our consolidated statement of cash flows for the ninemonths ended October 2, 2005 is as follows (in thousands):

 
| ** **                                              | ** ** | **Nine Months Ended  October 2, 2005** | ** ** |
|---------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                              | ** ** | **As   Reported**                           | ** ** | **As   Restated** | ** ** |
| ** **                                              | ** ** | **(in thousands)**                          | ** ** |
|                                                    |       |                                        |       |   |   |
| Operating activities:                                   |       |                                        |       |   |   |
| Accrued interest on notes payable                       |       | $                                           | 12,156     |   | — |   |
| Change in accrued interest on demand notes payable |       | —                                      |       | $ | (24,319 | ) |
| Net cash used in operating activities                   |       | (74,296                                     | )          | (110,771 | ) |
|                                                    |       |                                        |       |   |   |
| Investing activities:                                   |       |                                        |       |   |   |
| Net cash used in  investing activities                  |       | (19,767                                     | )          | (19,767 | ) |
|                                                    |       |                                        |       |   |   |
| Financing activities:                                   |       |                                        |       |   |   |
| Payments on demand notes payable                        |       | (36,475                                     | )          | — |   |
| Net cash provided by financing activities               |       | 168,796                                     |       | $ | 205,271 |   |
|                                                    |       |                                        |       |   |   |
| Effect of exchange rate  changes on cash                |       | (102                                        | )          | (102 | ) |
|                                                    |       |                                        |       |   |   |
| Net increase in cash  and cash equivalents              |       | 74,631                                      |       | 74,631 |   |
|                                                    |       |                                        |       |   |   |
| Cash and cash  equivalents, beginning of year           |       | 20,131                                      |       | 20,131 |   |
|                                                    |       |                                        |       |   |   |
| Cash and cash equivalents, end of period                |       | $                                           | 94,762     |   | $ | 94,762 |   |

 

**3.  Stock BasedCompensation**

 

Weaccount for our stock based compensation plans under the fair value recognitionprovisions of SFAS 123, *Accounting for StockBased Compensation. *Under thefair value method, compensation expense is measured at the grant date based onthe estimated fair value of the award. The fair value is estimated using the Black-Scholes option pricing modeland is recognized over the service period, which is typically the vestingperiod.   We recognized compensationexpense related to stock options of $1.4 million and $3.1 million for the threeand nine months ended October 2, 2005, respectively, as compared to thecompensation expense related to stock options of $416 thousand and $2.3 millionfor the three and nine months ended October 3, 2004, respectively.

 

Weused the Black-Scholes option pricing model, with a minimum value pricingmethod, for measuring the fair value of options granted for the year ended December 31,2004 and for the three month period ended April 3, 2005.  The minimum value pricing method does nottake into consideration volatility. In accordance with SFAS 123,subsequent to April 5, 2005, the date of our initial filing of theregistration statement relating to our initial public offering with theSecurities and Exchange Commission, we used the Black-Scholes model, includinga volatility assumption, to estimate the fair value of all option grants.Forfeitures and cancellations are recognized as they occur. Expense previouslyrecognized related to options that are cancelled or forfeited prior to vestingis reversed in the period of the cancellation or forfeiture.

 

Thefair value of options was estimated at the date of grant using theBlack-Scholes option pricing model with the following assumptions by plan:

 
| ** **              | ** ** | **October 2, 2005** | ** ** | **October 3, 2004** | ** ** |
|-------------------------|------------|--------------------------|------------|--------------------------|------------|
| ** **              | ** ** | **ev3 Inc.**             | ** ** | **MTI**                  | ** ** | **ev3 Inc.** | ** ** | **MTI** | ** ** |
| Risk free interest rate |       | 4.0                      | %          | 3.9                      | %          | 3.6 | % | 3.3 | % |
| Expected dividend yield |       | 0.0                      | %          | 0.0                      | %          | 0.0 | % | 0.0 | % |
| Expected volatility     |       | 50.0                     | %          | 45.9                     | %          | — |   | 64.0 | % |
| Expected option term    |       | 4 years                  |       | 4 years                  |       | 5 years |   | 4 years |   |

 

Inaccordance with the provisions of SFAS 123 and Emerging Issues Task ForceIssue 96-18, *Accounting for EquityInstruments that are Issued to Other than Employees for Acquiring, or inConjunction with Selling, Goods or Services*, we account fornon-employee equity based awards, in which goods or services are theconsideration received for the equity instruments issued, at their fair value.The assumptions used to determine fair value under the Black-Scholes pricingmodel are as disclosed above for ev3 Inc. and MTI as appropriate.

 

5

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**4.  New Accounting Pronouncements**

 

In November 2004,the FASB issued SFAS 151, *InventoryCosts, An Amendment of Accounting Research Bulletin No. 43, Chapter 4*,which adopts wording from the International Accounting Standards Board’s («IASB»)IAS 2 *Inventories* in an effort toimprove the comparability of cross-border financial reporting. The new standardindicates that abnormal freight, handling costs, and wasted materials(spoilage) are required to be treated as current period charges rather than asa portion of inventory cost. Additionally, the standard clarifies that fixedproduction overhead should be allocated based on the normal capacity of aproduction facility. The statement is effective for us beginning in 2006.Adoption is not expected to have a material impact on our results ofoperations, financial position or cash flows.

 

On December 16,2004, the FASB issued SFAS 123(R), *Share-BasedPayment*, which is a revision of SFAS 123 and supersedes APBOpinion 25. SFAS 123(R) requires all share-based payments to employees,including grants of employee stock options, to be valued at fair value on thedate of grant, and to be expensed over the applicable vesting period and iseffective for us on January 1, 2006. We have not yet determined the impactof the provisions of SFAS 123(R) on our results of operations, financialposition or cash flows.

 

**5. Liquidity and Capital Resources**

 

On June 21,2005, we completed an initial public offering in which we sold 11,765,000shares of common stock at $14.00 per share for net cash proceeds of $152.7million, net of underwriting discounts and other offering costs.  Immediately prior to the consummation of theoffering, ev3 LLC merged with and into ev3 Inc. and 24,040,718 Class Apreferred membership units, 41,077,336 Class B preferred membership units,and 18,799,962 common membership units of ev3 LLC were converted into83,918,016 shares of common stock of ev3 Inc. (on a pre-split basis).  Immediately thereafter, we completed a onefor six reverse stock split whereby the 83,918,016 shares of common stock wereconverted into 13,986,350 shares of common stock.  Prior to the consummation of the offering,and subsequent to the reverse stock split, we also issued 21,964,815 and1,194,489 shares of common stock to Warburg Pincus and Vertical, respectively,in exchange for their contribution of $324.2 million aggregate principal amountof demand notes and accrued and unpaid interest thereon.  The remaining balance of the accrued andunpaid interest on the demand notes, totaling $36.5 million, was repaid usingproceeds from the offering.  On July 20,2005, we sold an additional 205,800 shares of common stock pursuant to theover-allotment option granted to the underwriters in connection with theinitial public offering.  Net proceeds tous from this sale totaled $2.2 million, after deducting underwriting discountsand other offering expenses.   Total netcash proceeds to us from our initial public offering were $154.9 million.

 

*The following summarizes the changes in stockholders’ equity(deficit) since December 31, 2004:*

*(in thousands, except unit and share amounts)*

 
| ** **                                                                        | ** ** | ** **     | ** ** | ** **                 | ** ** | ** **       | ** **     | ** ** | ** ** | ** **                       | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** **  | ** ** | ** **                             | ** ** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------|------------|----------------------------|------------|------------------|----------------|------------|------------|----------------------------------|------------|------------------------------------------------------|-------------|------------|----------------------------------------|------------|------------|
| ** **                                                                        | ** ** | ** **     | ** ** | ** **                 | ** ** | ** **       | ** **     | ** ** | ** ** | **Additional  Paid In  Capital** | ** ** | ** **                                           | ** **  | ** ** | **Total  Stockholders’  Deficit** | ** ** |
| ** **                                                                        | ** ** | ** **     | ** ** | **Members’  Capital** | ** ** | **Common Stock** | ** **     | ** ** | ** ** | **Accumulated  Deficit**         | ** ** | ** **                                           |
| ** **                                                                        | ** ** | **Units**      | ** ** | ** **                 | **Shares** | ** **       | **Amount**     | ** ** | ** ** | ** **                       | ** ** | ** **                                           |
| **Balance January 1, 2005**                                                  | ** ** | **15,293,490** | ** ** | **$**                      | **47,927** | ** **       | **—**     | ** ** | **$**      | **—**                       | ** ** | **$**                                                | **—**  | ** ** | **$**                                  | **(1,694** | **)**      | **$** | **(440,705** | **)** | **$** | **(394,472** | **)** |
| Accretion of preferred membership units                                           |       | —         |       | —                     |       | —           |           | —     |       | —                           |       | —                                               |        | (6,426     | )                                      | (6,426     | )          |
| Compensation expense on unit options                                              |       | —         |       | 796                        |       | —           |           | —     |       | —                           |       | —                                               |        | —     |                                   | 796        |       |
| Exercise of unit options                                                          |       | 495,809        |       | 651                        |       | —           |           | —     |       | —                           |       | —                                               |        | —     |                                   | 651        |       |
| Comprehensive loss:                                                               |       |           |       |                       |       |             |           |       |       |                             |       |                                                 |        |       |                                   |       |       |
| Net loss                                                                          |       |           |       |                       |       |             |           |       |       |                             |       | —                                               |        | (32,369    | )                                      | (32,369    | )          |
| Cumulative translation adjustment                                                 |       |           |       |                       |       |             |           |       |       |                             |       | 770                                                  |        | —     |                                   | 770        |       |
| Comprehensive loss:                                                               |       |           |       |                       |       |             |           |       |       |                             |       | 770                                                  |        | (32,369    | )                                      | (31,599    | )          |
| **Balance April 3, 2005**                                                    | ** ** | **15,789,299** | ** ** | **$**                      | **49,374** | ** **       | **—**     | ** ** | **$**      | **—**                       | ** ** | **$**                                                | **—**  | ** ** | **$**                                  | **(924**   | **)**      | **$** | **(479,500** | **)** | **$** | **(431,050** | **)** |
| Accretion of preferred membership units                                           |       | —         |       | —                     |       | —           |           | —     |       | —                           |       | —                                               |        | (5,635     | )                                      | (5,635     | )          |
| Compensation expense on unit/stock options                                        |       | —         |       | 513                        |       | —           |           | —     |       | 409                              |       | —                                               |        | —     |                                   | 922        |       |
| Exercise of unit options                                                          |       | 6,331          |       | 9                          |       | —           |           | —     |       | —                           |       | —                                               |        | —     |                                   | 9          |       |
| Members’ contribution                                                        |       | 3,004,332      |       | $                          | 8,404      |             | —         |       | $          | —                           |       | $                                                    | —      |       | $                                      | —     |       | $ | — |   | $ | 8,404 |   |
| Conversion of preferred / common membership units                                 |       | (18,799,962    | )          | (58,300                    | )          | 83,918,016       |           | 839        |       | 323,550                          |       | —                                               |        | —     |                                   | 266,089    |       |
| 1-for-6 reverse common stock split                                                |       | —         |       | —                     |       | (69,931,666      | )              | (699       | )          | 699                              |       | —                                               |        | —     |                                   | —     |       |
| Contribution of demand notes                                                      |       | —         |       | —                     |       | 23,159,304       |           | 231        |       | 323,999                          |       | —                                               |        | —     |                                   | 324,230    |       |
| Common stock issued in conjunction with initial  public offering                  |       | —         |       | —                     |       | 11,765,000       |           | 118        |       | 152,595                          |       | —                                               |        | —     |                                   | 152,713    |       |
| Comprehensive loss:                                                               |       |           |       |                       |       |             |           |       |       |                             |       |                                                 |        |       |                                   |       |       |
| Net loss                                                                          |       |           |       |                       |       |             |           |       |       |                             |       | —                                               |        | (35,222    | )                                      | (35,222    | )          |
| Cumulative translation adjustment                                                 |       |           |       |                       |       |             |           |       |       |                             |       | 643                                                  |        | —     |                                   | 643        |       |
| Gain on change in ownership % of MTI                                              |       |           |       |                       |       |             |           |       |       |                             |       | —                                               |        | 149        |                                   | 149        |       |
| Comprehensive loss:                                                               |       |           |       |                       |       |             |           |       |       |                             |       | 643                                                  |        | (35,073    | )                                      | (34,430    | )          |
| **Balance July 3, 2005**                                                     |       | —         | ** ** | **$**                      | **—** | ** **       | **48,910,654** | ** ** | **$**      | **489**                          | ** ** | **$**                                                | **801,252** | ** ** | **$**                                  | **(281**   | **)**      | **$** | **(520,208** | **)** | **$** | **281,252** | ** ** |
| Compensation expense on stock options                                             |       | —         |       | —                     |       | —           |           | —     |       | 1,352                            |       | —                                               |        | —     |                                   | 1,352      |       |
| Common stock issued in conjunction with initial  public offering (over-allotment) |       | —         |       | —                     |       | 205,800          |           | 2          |       | 2,231                            |       | —                                               |        | —     |                                   | 2,233      |       |
| Exercise of unit options                                                          |       | —         |       | —                     |       | 31,500           |           | —     |       | 251                              |       | —                                               |        | —     |                                   | 251        |       |
| Comprehensive loss:                                                               |       |           |       |                       |       |             |           |       |       |                             |       |                                                 |        |       |                                   |       |       |
| Net loss                                                                          |       |           |       |                       |       |             |           |       |       |                             |       | —                                               |        | (20,457    | )                                      | (20,457    | )          |
| Cumulative translation adjustment                                                 |       |           |       |                       |       |             |           |       |       |                             |       | 111                                                  |        | —     |                                   | 111        |       |
| Gain on change in ownership % of MTI                                              |       |           |       |                       |       |             |           |       |       |                             |       | —                                               |        | 2          |                                   | 2          |       |
| Comprehensive loss:                                                               |       |           |       |                       |       |             |           |       |       |                             |       | 111                                                  |        | (20,455    | )                                      | (20,344    | )          |
| **Balance October 2, 2005**                                                  |       | —         | ** ** | **$**                      | **—** | ** **       | **49,147,954** | ** ** | **$**      | **491**                          | ** ** | **$**                                                | **805,086** | ** ** | **$**                                  | **(170**   | **)**      | **$** | **(540,663** | **)** | **$** | **264,744** | ** ** |

 

6

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Comprehensiveloss consists of net loss, gains on changes of interest related to ownershipchanges in MTI, and the effects of foreign currency translation.  The components of comprehensive loss resultedin a decrease to our net loss of $113 thousand and $1.7 million for the threeand nine months ended October 2, 2005, respectively.

 

Ourfuture liquidity and capital requirements will be influenced by numerousfactors, including clinical research and product development programs, receiptof and time required to obtain regulatory clearances and approvals, sales andmarketing programs and continuing acceptance of our products in themarketplace. We believe that the resources generated through our initial publicoffering are sufficient to meet our liquidity requirements through the end offiscal 2006; however, if we require additional working capital, but are notable to raise additional funds, we may be required to significantly curtail orcease ongoing operations.

 

**6. MTI Step Acquisitions**

 

Throughour wholly owned subsidiary, MII, we have acquired a controlling interest inMTI in various step investments.  MTI isa publicly held Delaware corporation that develops, manufactures and marketsminimally invasive medical devices for diagnosis and treatment primarily ofneurovascular diseases. The investments were accounted for using the stepacquisition method prescribed by ARB 51, *ConsolidatedFinancial Statements*. Step acquisition accounting requires theallocation of the excess purchase price to the fair value of net assetsacquired. The excess purchase price is determined as the difference between thecash paid and the historical book value of the interest in net assets acquired.

 

On May 26,2005, the shares of MTI’s common stock directly held by Warburg Pincus andVertical were contributed to ev3 LLC in exchange for 10,804,500 and 3,004,332common membership units (pre-split basis), respectively.  These common membership units weresubsequently converted into shares of ev3 Inc. common stock in connection withthe subsequent merger of ev3 LLC with and into ev3 Inc. on June 21,2005.  MTI shares contributed by WarburgPincus, representing a 15.7% interest in MTI, have been accounted for as atransfer of assets between entities under common control and these consolidatedfinancial statements give effect to the contribution by

 

7

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WarburgPincus as though such contributions occurred in 2003 and 2004 when WarburgPincus acquired its interest in MTI. Shares of MTI contributed by Vertical,representing a 4.3% interest, have been accounted for under the purchase methodof accounting at the date of the contribution by Vertical.  As a result, we held an approximate interestin MTI of 70.2% and 66.0% at October 2, 2005 and December 31, 2004,respectively.

 

Thenumber of membership units of ev3 LLC issued in exchange for the MTI sharesdirectly held by Warburg Pincus and Vertical was determined based on fairvalue.  Fair value of the MTI sharescontributed was measured as the average closing price per share of MTI’s commonstock on the NASDAQ National Market System for the twenty trading days from andincluding the date our Registration Statement with respect to our initialpublic offering was first filed by us with the Securities and ExchangeCommission. Fair value of ev3 LLC’s equity issued in exchange for the MTIshares was based on the midpoint of the range of estimated initial publicoffering prices per share, after consideration of the reverse stock split (SeeNote 2).

 

*The following summarizes the allocation of the excesspurchase price over historical book values arising from the May 26, 2005contribution of MTI shares by Vertical (in thousands):*

 
| ** **                                    | ** ** | **May 26,  2005** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|
|                                          |       |                   |       |
| Inventory                                     |       | $                      | 104        |   |
| Developed  technology                         |       | 2,043                  |       |
| Customer  relationships                       |       | 894                    |       |
| Trademarks and  tradenames                    |       | 458                    |       |
| Acquired in-process  research and development |       | 868                    |       |
| Goodwill                                      |       | 2,066                  |       |
| Minority  interest                            |       | 2,021                  |       |
| Accrued  liabilities                          |       | (50                    | )          |
|                                          |       |                   |       |
| Total                                         |       | $                      | 8,404      |   |

 

Theacquired in-process research and development charge was estimated consideringan appraisal and represents the estimated fair value of the in-process projectsat the date of contribution of the MTI shares. As of the acquisition date, the in-process projects had not yet reachedtechnological feasibility and had no alternative use. The primary basis fordetermining technological feasibility of these projects is obtaining regulatoryapproval to market the products. Accordingly, the value attributable to theseprojects, which had yet to obtain regulatory approval, was expensed inconjunction with the acquisition. If the projects are not successful, orcompleted in a timely manner, we may not realize the financial benefitsexpected from these projects.

 

To theextent that investments in MTI by third party investors reduced our ownershipinterest, the difference between the carrying value of the interest indirectlysold by us, and the consideration paid by the third party investor isconsidered a change in interest transaction. We have adopted an accountingpolicy of recording change of interest gains or losses within equity aspermitted by Staff Accounting Bulletin (“SAB”) 5H. Change of interest gainsrecorded in equity were $2 thousand and $151 thousand for the three and ninemonths ended October 2, 2005, respectively, as compared with $1.3 millionand $2.1 million for the three and nine months ended October 3, 2004,respectively.

 

**7.  Short-terminvestments**

 

Short-terminvestments consist of debt securities of corporations, which have investmentgrade credit ratings.  The debtsecurities are classified and accounted for as available-for-sale and arereported at fair value with unrealized gains and losses excluded from earningsand reported in other comprehensive income. Management determines theappropriate classification of our investments in securities at the time ofpurchase and reevaluates such determination

 

8

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ateach balance sheet date.  As of October 2,2005, there were no significant unrealized gains or losses related to theseinvestments.

 

**8.  Inventories**

 

*Inventory consists of the following (in thousands):*

 
| ** **         | ** ** | **October 2,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **         | ** ** | ** **                | ** ** | ** **                  | ** ** |
| Raw materials      |       | $                         | 6,256      |                        | $          | 6,874 |   |
| Work-in-progress   |       | 1,822                     |       | 1,832                       |       |
| Finished goods     |       | 27,650                    |       | 17,481                      |       |
|               |       |                      |       |                        |       |
|               |       | 35,728                    |       | 26,187                      |       |
| Inventory  reserve |       | (3,817                    | )          | (3,687                      | )          |
|               |       |                      |       |                        |       |
| Inventory, net     |       | $                         | 31,911     |                        | $          | 22,500 |   |

 

**9. Goodwill and Other Intangible Assets**

 

 *The changes in the carrying amount of goodwill byoperating segment for the three and nine months ended October 2, 2005 wereas follows (in thousands):*

 
| ** **                                                | ** ** | **Cardio  Peripheral** | ** ** | **Neuro-  vascular** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------|------------|------------------------|------------|----------------------|------------|-----------|------------|
|                                                      |       |                   |       |                 |       |      |       |
| Balance as of January 1,  2005                       |       | $                      | 73,431     |                 | $          | 21,083    |       | $ | 94,514 |   |
| Settlement of litigation over purchase price  adjustments |       | (2,124                 | )          | —               |       | (2,124    | )          |
|                                                      |       |                   |       |                 |       |      |       |
| Balance as of April 3,  2005                         |       | 71,307                 |       | 21,083               |       | 92,390    |       |
| Goodwill related to MTI step acquisitions                 |       | —                 |       | 2,066                |       | 2,066     |       |
|                                                      |       |                   |       |                 |       |      |       |
| Balance as of July 3,  2005                          |       | $                      | 71,307     |                 | $          | 23,149    |       | $ | 94,456 |   |
|                                                      |       |                   |       |                 |       |      |       |
| Balance as of October 2,  2005                       |       | $                      | 71,307     |                 | $          | 23,149    |       | $ | 94,456 |   |

 

9

----

 

*Other intangible assets consist of the following (inthousands):*

 
| ** **                  | ** ** | **Weighted  average  useful life  (in years)** | ** ** | **October 2, 2005**  | ** ** | **December 31, 2004**  | ** ** |
|-----------------------------|------------|------------------------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization**                  | ** ** | **Net  Carrying  Amount** | ** ** | **Gross  Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** | **Net  Carrying  Amount** | ** ** |
| Patents and  licenses       |       | 5.0                                            |       | $                         | 4,545      |                        | $          | (1,827 | ) | $ | 2,718 |   | $ | 3,496 |   | $ | (1,655 | ) | $ | 1,841 |   |
| Developed  technology       |       | 6.0                                            |       | 51,472                    |       | (29,156                     | )          | 22,316 |   | 47,836 |   | (21,126 | ) | 26,710 |   |
| Trademarks and  tradenames  |       | 5.0                                            |       | 3,085                     |       | (1,535                      | )          | 1,550 |   | 2,627 |   | (1,041 | ) | 1,586 |   |
| Customer  relationships     |       | 5.0                                            |       | 6,071                     |       | (4,144                      | )          | 1,927 |   | 5,177 |   | (3,463 | ) | 1,714 |   |
|                        |       |                                           |       |                      |       |                        |       |   |   |   |   |   |   |   |   |
| Other intangible  assets    |       |                                           |       | $                         | 65,173     |                        | $          | (36,662 | ) | $ | 28,511 |   | $ | 59,136 |   | $ | (27,285 | ) | $ | 31,851 |   |

 

Intangibleassets are amortized using methods which approximate the benefit provided bythe utilization of the assets. Patents and licenses, developed technology andtrademarks and tradenames are amortized on a straight line basis. Customerrelationships are amortized using the double declining balance method. Wecontinually evaluate the amortization period and carrying basis of intangibleassets to determine whether later events and circumstances warrant a revisedestimated useful life or reduction in value.

 

Totalamortization of intangibles was $2.7 million and $7.9 million for the three andnine months ended October 2, 2005, respectively, as compared to $2.4million and $7.4 million for the three and nine months ended October 3,2004.  The estimated amortization expense(inclusive of amortization expense already recorded for the nine months ended October 2,2005) for the five years ending December 31 is as follows (in thousands):

 
| 2005 |   | $     | 10,592 |   |
|------|--------|-------|--------|--------|
| 2006 |   | 9,409 |   |
| 2007 |   | 7,140 |   |
| 2008 |   | 3,818 |   |
| 2009 |   | 1,369 |   |

 

**10. Investments**

 

MTIhad a licensing agreement and an approximate 14% interest in Genyx Medical, Inc.(“Genyx”). The carrying value of MTI’s investment in Genyx was $0 as of December 31,2004, and MTI had no obligation to fund Genyx’s operations. In January 2005,MTI sold its interest in Genyx and recorded a gain of $3.7 million.

 

Inconnection with the 2002 sale of its investment in Enteric Medical Technologies, Inc.,MTI has a right to receive certain contingent consideration.  During May 2005 and May 2004, MTIreceived $878 thousand and $1.7 million, respectively, based upon theachievement of certain milestones.  These receipts were recognized as additional gain on sale of investmentwhen received by MTI.

 

**11. Accrued Liabilities**

 

*Accrued liabilities consist of the following (in thousands):*

 
| ** **                     | ** ** | **October 2,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | ** **                | ** ** | ** **                  | ** ** |
| Accrued  professional services |       | $                         | 4,427      |                        | $          | 3,591 |   |
| Accrued clinical  studies      |       | 1,765                     |       | 1,580                       |       |
| Accrued other                  |       | 5,918                     |       | 8,650                       |       |
|                           |       |                      |       |                        |       |
| Total accrued liabilities      |       | $                         | 12,110     |                        | $          | 13,821 |   |

 

10

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**12. Debt**

 

At June 21,2005, the closing date of our initial public offering, ev3 Endovascular hadoutstanding $316.0 million aggregate principal amount of demand notes plus$44.7 million of accrued and unpaid interest thereon.  These notes were payable to Warburg Pincus, ourmajority stockholder, and Vertical, our second largest stockholder.  Immediately prior to our initial publicoffering, we issued 21,964,815 and 1,194,489 shares of common stock to WarburgPincus and Vertical, respectively, in exchange for their contribution of $324.2million principal amount of the demand notes and a portion of the accrued andunpaid interest thereon.  Upon successfulconsummation of our initial public offering, we utilized $36.5 million of thenet proceeds to repay the remaining accrued and unpaid interest, reducing ourdebt balance to zero at June 21, 2005.

 

On May 6,2005, MTI entered into a Loan and Security Agreement (the “Loan Agreement”)with Silicon Valley Bank (“SVB”), which will expire on May 6, 2007.Pursuant to the terms of the Loan Agreement, MTI may borrow up to the lesser of(i) $3.0 million or (ii) the sum of (a) 80% of MTI’s eligibleaccounts receivable, which exclude among other things accounts receivablerelating to international sales, and (b) the lesser of (1) 30% of MTI’seligible inventory, which excludes among other things inventory located outsideof the United States, (2) 50% of outstanding loans under (a) above or(3) $750 thousand. All outstanding amounts under the Loan Agreement bearinterest at a variable rate equal to SVB’s prime rate plus 2%. The LoanAgreement also contains customary covenants regarding operations of MTI’sbusiness and financial covenants relating to minimum tangible net worth.  As of October 2, 2005, MTI had noborrowings under the Loan Agreement.

 

On October 13,2005, MTI entered into a lease for approximately 96,400 square feet of newoffice, research and manufacturing space. In order to provide MTI with financing to support planned improvementsand anticipated moving expenses, which are preliminarily estimated to beapproximately $2.3 million, we agreed to provide MTI with an unsecured loan upto $2.3 million and ev3 Endovascular issued a $1.0 million standby irrevocableletter of credit in favor of the landlord (See Note 19).

 

**13. Redeemable Convertible Preferred Membership Units**

 

Inconnection with the merger of ev3 LLC with and into ev3 Inc., 24,040,718 Class Apreferred membership units of ev3 LLC with a carrying value of $98.7 millionand 41,077,336 Class B preferred membership units of ev3 LLC with acarrying value of $167.4 million were converted into common membership units ofev3 LLC, and subsequently into shares of our common stock, on a 1:1 basis.  The newly converted shares were then subjectto a 1-for-6 reverse stock split (See Note 2).

 

Pursuantto the terms of the preferred membership units, prior to conversion they werebeing accreted to a redemption value, but such accretion was discontinued atthe date of conversion to common stock (See Note 2).

 

**14. Equity Based Compensation Plans**

 

Underthe ev3 Inc. 2005 Incentive Stock Plan (the “2005 Plan”), 2,000,000 shares ofour common stock are available for issuance, subject to adjustment as providedin the 2005 Plan. Under the 2005 Plan, our eligible employees, outsidedirectors and consultants may be awarded options, stock grants, stock units orstock appreciation rights. The terms and conditions of an option, stock grant,stock unit or stock appreciation right (including any vesting or forfeitureconditions) areset forth in the certificate evidencing the grant.  During the three months ended October 2,2005, options to purchase 19,641 shares of our common stock were granted.  Upon consummation of our initial publicoffering, the ev3 LLC 2003 Incentive Plan was terminated with respect tooptions available for grant that were not granted prior to the offering.

 

11

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**15.  Interest (income)expense**

 

*Interest(income) expense consists of the following (in thousands):*

 
| ** **                      | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|---------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                      | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** |
| Interest expense                |       | $                         | 20         |                      | 9,896      |   | $ | 12,211 |   | $ | 20,702 |   |
| Interest  (income)              |       | (973                      | )          | (94                       | )          | (1,378 | ) | (287 | ) |
| Total interest (income) expense |       | $                         | (953       | )                         | $          | 9,802 |   | $ | 10,833 |   | $ | 20,415 |   |
|                                 |            |                           |            |                           |            |  |  |  |  |  |  |  |  |

 

**16. Commitments and Contingencies**

 

*Letters of Credit*

 

As of October 2,2005, we had $2.7 million of outstanding letters of credit. These outstandingcommitments are fully collateralized by restricted cash.

 

*Contingencies*

 

Our acquisition agreements relating to the purchase ofMitraLife, Appriva Medical, Inc. and Dendron GmbH require us to makeadditional payments to the sellers of these businesses if certain milestonesrelated to regulatory steps in the product commercialization process areachieved. The potential milestone payments total $25.0 million,$175.0 million and $15.0 million with respect to the MitraLife,Appriva and Dendron acquisitions, respectively, during the period of 2003 to2009. On September 29, 2004, we sold substantially all of the assetsconstituting the MitraLife business to Edwards Lifesciences and are no longerpursuing commercialization of the product line acquired in the MitraLifetransaction.  As of the date that we soldthese assets to Edwards Lifesciences, none of the milestones set forth in ouragreement with the sellers of MitraLife had been met.  We have determined that we have no currentobligations in respect of these milestone payments, and we do not believe thatit is likely that we will have obligations with respect to these milestones inthe future.  We have determined that thefirst milestone with respect to the Appriva agreement was not achieved by the January 1,2005 milestone date and that the first milestone is not payable.  On September 27, 2005, we announced thatwe have decided to discontinue the development and commercialization of ourPLAATO device, which is the technology we acquired in the Apprivatransaction.  Although we recently hadobtained conditional approval from the FDA for an investigational deviceexemption, or IDE, clinical trial for the PLAATO device, we determined that,due to the time, cost and risk of enrollment, the trial design ultimatelymandated by the FDA was not commercially feasible for us at this time.  We continue to keep all of our options openwith regard to the future of the PLAATO technology, which may include a sale orlicensing of the technology to third parties. Under the terms of the stock purchase agreement we entered into inconnection with our acquisition of Dendron, we may be required to makeadditional payments which are contingent upon Dendron products achievingcertain revenue targets between 2003 and 2008. In 2003, the $4.0 millionrevenue target for sales of Dendron products during 2003 was met. Accordingly,an additional payment to the former Dendron stockholders of $3.75 millionwas made in 2004. In 2004, the $5.0 million revenue target for sales ofDendron products during 2004 was met. Accordingly, a payment to the formerDendron stockholders of $3.75 million was accrued in 2004 and was paidduring the second quarter of 2005. We may be required to make a final paymentof $7.5 million, which is contingent upon Dendron products achievingannual revenues of $25 million in any year during the period between 2003and 2008. Any such final payment would be due in the year following the year oftarget achievement.

 

In connection with the acquisition of Dendron on October 4,2002, MTI terminated the then-existing distribution agreements withsubstantially all of Dendron’s distributors. One such distributor has indicatedits intent to pursue what it believes are its rights against MTI, however, the amountthat might be sought by such distributor is unknown. MTI believes it hassatisfied its obligations to all the former Dendron distributors, and,accordingly, believes that losses from future claims, if any, are not probableas defined by SFAS No. 5 “Accounting for Contingencies”.

 

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We are from time to time subject to, and are presentlyinvolved in, litigation or other legal proceedings.

 

In September 2000, Dendron, which was acquired byMTI in 2002, was named as the defendant in three patent infringement lawsuitsbrought by the Regents of the University of California, as the plaintiff, inthe District Court (Landgericht) in Dusseldorf, Germany.  The complaints requested a judgment thatDendron’s EDC I coil device infringed three European patents held by theplaintiff and asked for relief in the form of an injunction that would preventDendron from producing and selling the devices within Germany and selling fromGermany to physician customers abroad, as well as an award of damages caused byDendron’s alleged infringement, and other costs, disbursements and attorneys’fees.  In August 2001, the courtissued a written decision that EDC I coil devices did infringe the plaintiff’spatents, enjoined Dendron from selling the devices within Germany and fromGermany to physician customers abroad, and requested that Dendron disclose theindividual products’ costs as the basis for awarding damages.  In September 2001, Dendron appealed thedecision.  In addition, Dendroninstituted challenges to the validity of each of these patents by filingopposition proceedings with the European Patent Office, or EPO, against one ofthe patents (MTI joined Dendron in this action in connection with itsacquisition of Dendron), and by filing, with MTI, nullity proceedings with theGerman Federal Patents Court against the German component of the other twopatents.  The opposition proceedings withthe EPO on the one patent are complete, and the EPO has rejected the oppositionand has upheld the validity of the one patent.

 

On July 4, 2001, the University of Californiafiled another suit against Dendron alleging that the EDC I coil deviceinfringed another European patent held by the plaintiff.  The complaint was filed in the District Courtof Dusseldorf, Germany seeking additional monetary and injunctive relief.  In April 2002, the Court found that EDCI coil devices did infringe the plaintiff’s patent.  The patent involved is the same patent thatwas involved in the case before the English Patents Court discussed below andthat was ruled by a Dutch court to be invalid, also discussed below.  The opposition proceedings on the patent arecomplete, and the EPO has rejected the opposition and has upheld the validityof the patent.  The case is under appealand an oral hearing is scheduled to be held in the Dusseldorf Court of Appealon March 9, 2006.

 

An accrual for the matters discussed above wasincluded in the balance sheet of Dendron as of the date of its acquisition byMTI. As of October 2, 2005, approximately $800 thousand was recorded inaccrued liabilities in our consolidated financial statements included in thisreport.  Dendron ceased all activitieswith respect to the EDC I coil device prior to MTI’s October 2002acquisition of Dendron.

 

Concurrent with its acquisition of Dendron, MTIinitiated a series of legal actions related to its Sapphire coils in theNetherlands and the United Kingdom, which included a cross-border action thatwas heard by a Dutch court, as further described below.  The primary purpose of these actions was toassert both invalidity and non-infringement by MTI of certain patents held byothers.  The range of patents at issueare held by the Regents of the University of California, with Boston ScientificCorporation subsidiaries named as exclusive licensees, collectively referred toas the «patent holders,» related to detachable coils and certain deliverycatheters.

 

In October 2003, the Dutch court ruled the threepatents at issue related to detachable coils are valid and that MTI’s Sapphirecoils do infringe such patents.  TheDutch court also ruled that the patent holders’ patent at issue related to thedelivery catheter was invalid.  Pursuantto the court’s ruling, MTI has been enjoined from engaging in infringingactivities related to the Sapphire coils in most countries within the EuropeanUnion, and may be liable for then-unspecified monetary damages for activitiesengaged in by MTI since September 27, 2002.  In February 2005, MTI received aninitial claim from the patent holders with respect to monetary damages,amounting to €3.6 million, or approximately $4.3 million as of October 2,2005, with which MTI disagrees.  Courthearings will be held regarding these claims. MTI has filed an appeal with the Dutch court, and believes that since thedate of injunction in each separate country it is in compliance with the Dutchcourt’s injunction and MTI intends to continue such compliance. Because webelieve that MTI has valid legal grounds for appeal, we have determined that aloss is not probable at this time as defined by SFAS 5, *Accounting for Contingencies.*  However, there can be no assurance that theultimate resolution of this matter will not result in a material adverse effecton our business, financial condition or results of operations.

 

In January 2003, MTI initiated a legal action inthe English Patents Court seeking a declaration that a patent held by thepatent holders related to delivery catheters was invalid, and that MTI’sproducts did not infringe this patent. The patent in question was the U.K. designation of the same patent thatwas found by the Dutch court in October 2003 to

 

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be invalid, as discussed above.  The patent holders counterclaimed for allegedinfringement by MTI. In February 2005, the court approved an interimsettlement between the parties under which the patent holders are required tosurrender such patent to the U.K. Comptroller of Patents, and to pay MTI’scosts associated with the legal action, including interest.  As a result, MTI received interim paymentsfrom the patent holders aggregating £500 thousand (equivalent to approximately$900 thousand based on the dates of receipt), which MTI recorded as a reductionof litigation expense upon receipt of such funds in February and March 2005.  The parties intend to continue discussionsregarding payment by the patent holders of the remaining costs incurred by MTIin such litigation.  As a result of theinterim settlement, MTI anticipates that it will no longer be involved inlitigation in the United Kingdom, although no assurance can be given that noother litigation involving MTI may arise in the United Kingdom.

 

In the United States, concurrent with the FDA’smarketing clearance of the Sapphire line of embolic coils received in July 2003,MTI initiated a declaratory judgment action against the patent holders in theUnited States District Court for the Western District of Wisconsin.  The action included assertions ofnon-infringement by MTI and invalidity of a range of patents held by the patentholders related to detachable coils and certain delivery catheters.  In October 2003, the court dismissed MTI’sactions for procedural reasons without prejudice and without decision as to themerits of the parties’ positions.  In December 2003,the University of California filed an action against MTI in the United StatesDistrict Court for the Northern District of California alleging infringement byMTI with respect to a range of patents held by the University of Californiarelated to detachable coils and certain delivery systems. MTI has filed acounterclaim against the University of California asserting non-infringement byMTI, invalidity of the patents and inequitable conduct in the procurement ofcertain patents.  In addition, MTI fileda claim against the University of California and Boston Scientific Corporationfor violation of federal antitrust laws, with the result that the court hassubsequently decided to add Boston Scientific as a party to the litigation.  A trial date has not been set. Because thesematters are in early stages, we cannot estimate the possible loss or range ofloss, if any, associated with their resolution. However, there can be no assurance that the ultimate resolution of thesematters will not result in a material adverse effect on our business, financialcondition or results of operations.

 

In March 2005, Medtronic, Inc. contacted usto express its view that our Protégé stents infringe on one or more of itspatents. We informed Medtronic that we disagree with its assertions, and havesince had several discussions with Medtronic. No lawsuit with respect to this matter has been filed. We also receivednotice from an individual claiming that he believes that our PLAATO deviceinfringes on two of his patents.  We haveinformed this individual that we do not believe that our PLAATO deviceinfringes on these patents.  We have alsoinformed this individual of our decision to discontinue the development andcommercialization of the PLAATO device. On March 30, 2005, we were served with a complaint by BostonScientific Corporation and one of its affiliates which claims that some of ourproducts, including our SpideRX Embolic Protection Device, infringe certain ofBoston Scientific’s patents.  This actionwas brought in the United States District Court for the District ofMinnesota.  We have answered thecomplaint and intend to vigorously defend this action. Because these mattersare in early stages, we cannot estimate the possible loss or range of loss, ifany, associated with their resolution. However, there can be no assurance that the ultimate resolution of thesematters will not result in a material adverse effect on our business, financialcondition or results of operations.

 

The acquisition agreement relating to our acquisitionof Appriva Medical, Inc. contains four milestones to which paymentsrelate.  The first milestone was required by its terms to be achieved by January 1,2005 in order to trigger a payment equal to $50 million.  We havedetermined that the first milestone was not achieved by January 1, 2005and that the first milestone is not payable.  On May 20, 2005,Michael Lesh,  as an individual seller of Appriva stockand purporting to represent certain othersellers of Appriva stock, filed a complaint in the SuperiorCourt of the State of Delaware with individually specified damages aggregating$70 million and other unspecified damages for several allegations,including that we, along with other defendants, breached the acquisitionagreement and an implied covenant of good faith and fair dealing by willfullyfailing to take the steps necessary to meet the first milestone under theagreement, and thereby also failing to meet certain other milestones, andfurther that one milestone was actually met.  The complaint also allegesfraud, negligent misrepresentation and violation of state securities laws inconnection with the negotiation of the acquisition agreement.  We believethese allegations are without merit and intend to vigorously defend this action. We filed a motion to dismiss the complaint. A hearing is expected to be held on this motion in January 2006.  The parties have not engaged in anydiscovery.  On August 5, 2005, ourattorneys received a letter from attorneys representing certain other sellersof Appriva stock (who are not purported to be represented in the action filedby Lesh), asking our attorneys to enter into a dialogue regarding theirassertions

 

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that certain milestones should have been paid. Webelieve their assertions are without merit. Failure to reach agreement with these new claimants on a resolution ofour differences could lead to additional litigation on this matter. Because these matters are in an early stage, we cannot estimate the possibleloss or range of loss, if any, associated with their resolution. However, therecan be no assurance that the ultimate resolution of these matters will notresult in a material adverse effect on our business, financial condition or resultsof operations.

 

On October 10, 2005, we announced that we haddelivered a proposal to MTI to acquire all of the outstanding shares of commonstock of MTI that we do not already own and on November 14, 2005 weannounced that we and MII had entered into an Agreement and Plan of Merger withMTI. (See Note 19).  On October 11,2005, a purported stockholder class action lawsuit related to our proposal toacquire all of the outstanding shares of common stock of our majority-ownedsubsidiary, Micro Therapeutics, Inc., that we do not already own, wasfiled in the Court of Chancery of the State of Delaware, in and for New CastleCounty, Delaware, naming MTI and each of its directors and ev3 Inc. asdefendants.  The complaint alleges thatthe defendants have and are breaching their fiduciary duties to the detrimentof MTI’s stockholders by, among other things, denying MTI’s public stockholdersthe opportunity to obtain fair value for their equity interests by proposing atransaction at an inadequate premium. The complaint seeks the following relief: (1) certification of thelawsuit as a class action; (2) an injunction preventing the completion ofthe proposed transaction; (3) rescission of the proposed transaction orrescissory damages to the extent the proposed transaction is alreadyimplemented prior to final judgment; (4) compensation for the plaintiffand other members of the class for all damages sustained as a result of thedefendants’ conduct; (5) directing that the defendants account to theplaintiff and other members of the class for all profits and any specialbenefits obtained as a result of their conduct; (6) costs anddisbursements of the lawsuit, including attorneys’ fees and expenses; and (7) suchother relief as the court may find just and proper.  We believe this lawsuit is without merit andplan to defend it vigorously.  Becausethis matter is in an early stage, we cannot estimate the possible loss or rangeof loss, if any, associated with the resolution.  However, there can be no assurance that the ultimateresolution of this matter will not result in a material adverse effect on ourbusiness, financial condition or results of operations.

 

**17. Segment and Geographic Information**

 

*Thefollowing is segment and geographic information (in thousands):*

 
| ** **                          | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|-------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                          | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** |
| **Segment  Data**                   |       |                      |       |                      |       |   |   |   |   |
| **Net  sales**                      |       |                      |       |                      |       |   |   |   |   |
| **Cardio  Peripheral**              |       |                      |       |                      |       |   |   |   |   |
| Stents                              |       | $                         | 9,913      |                      | $          | 4,772 |   | $ | 25,792 |   | $ | 14,777 |   |
| Thrombectomy and embolic protection |       | 2,949                     |       | 1,748                     |       | 9,410 |   | 5,683 |   |
| Procedural support and other        |       | 6,981                     |       | 5,528                     |       | 20,690 |   | 17,320 |   |
| Total Cardio Peripheral             |       | $                         | 19,843     |                      | $          | 12,048 |   | $ | 55,892 |   | $ | 37,780 |   |
|                                |       |                      |       |                      |       |   |   |   |   |
| **Neurovascular**                   |       |                      |       |                      |       |   |   |   |   |
| Embolic products                    |       | 6,220                     |       | 2,850                     |       | 14,417 |   | 8,337 |   |
| Neuro access and delivery products  |       | 7,437                     |       | 4,756                     |       | 22,413 |   | 14,686 |   |
| Total Neurovascular                 |       | $                         | 13,657     |                      | $          | 7,606 |   | $ | 36,830 |   | $ | 23,023 |   |
|                                |       |                      |       |                      |       |   |   |   |   |
| Total net sales                     |       | $                         | 33,500     |                      | $          | 19,654 |   | $ | 92,722 |   | $ | 60,803 |   |
| ** **                          | ** ** | ** **                | ** ** | ** **                | ** ** | ** ** |   |   |   |
| **Gross  Profit**                   | ** ** | ** **                | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cardio peripheral                   |       | $                         | 10,343     |                      | $          | 5,804 |   | $ | 29,344 |   | $ | 20,140 |   |
| Neurovascular                       |       | 9,567                     |       | 4,523                     |       | 24,894 |   | 13,179 |   |
| Total gross profit (1)              |       | 19,910                    |       | 10,327                    |       | 54,238 |   | 33,319 |   |
| Operating expenses                  |       | 41,816                    |       | 22,504                    |       | 134,425 |   | 95,201 |   |
| Loss from operations                |       | $                         | (21,906    | )                         | $          | (12,177 | ) | $ | (80,187 | ) | $ | (61,882 | ) |

 

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(1) Grossprofit for internal measurement purposes is defined as net sales less cost ofgoods sold excluding the amortization of intangible assets.

 

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| ** **        | ** ** | **October 2,  2005** | ** ** | **December 31,  2004** | ** ** |
|-------------------|------------|---------------------------|------------|-----------------------------|------------|
| **Total  assets** | ** ** | ** **                | ** ** | ** **                  | ** ** |
| Cardio Peripheral |       | $                         | 255,652    |                        | $          | 146,722 |   |
| Neurovascular     |       | 58,902                    |       | 65,324                      |       |
| Total assets      |       | $                         | 314,554    |                        | $          | 212,046 |   |

 
|                 | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|----------------------|------------|---------------------------|------------|---------------------------|------------|
|                 | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** |
| **Geographic  Data** | ** ** | ** **                | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Net  sales**       | ** ** | ** **                | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States Int    |       | $                         | 19,081     | ** **                | $          | 10,178 10 |   | $ | 49,141 |   | $ | 30,888 |   |
| International        |       | 14,419                    |       | 9,476                     |       | 43,581 |   | 29,915 |   |
| Total net sales      |       | $                         | 33,500     |                      | $          | 19,654 |   | $ | 92,722 |   | $ | 60,803 |   |

 

**18. Net Loss Per Share**

 

Thefollowing outstanding convertible preferred units of ev3 LLC, convertibledemand notes, and options to purchase shares of our common stock and commonmembership interests of ev3 LLC were excluded from the computation of dilutednet loss per share as they had an antidilutive effect.  In connection with the merger of ev3 LLC withand into ev3 Inc. immediately prior to our initial public offering, eachpreferred membership unit of ev3 LLC was converted into a share of ev3 Inc.common stock and each option to purchase common membership units of ev3 LLC wasconverted into an option to purchase an equivalent number of shares of ourcommon stock (see Note 13).

 
| ** **                                                                                                        | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                                                        | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** |
| ** **                                                                                                        | ** ** | ** **                | ** ** | ** **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| Convertible preferred stock class A (assuming  conversion using the Contractual conversion ratio to common units) |       | —                    |       | 4,006,786                 |       | — |   | 4,006,786 |   |
| Convertible preferred stock class B (assuming  conversion using the contractual conversion ratio to common units) |       | —                    |       | 6,846,223                 |       | — |   | 6,846,223 |   |
| Convertible demand notes (assuming conversion at  stated value into common units)                                 |       | —                    |       | 13,389,342                |       | — |   | 13,389,342 |   |
| Options                                                                                                           |       | 3,470,407                 |       | 1,588,171                 |       | 3,470,407 |   | 1,588,171 |   |
|                                                                                                              |       | 3,470,407                 |       | 25,830,522                |       | 3,470,407 |   | 25,830,522 |   |

 

**19. Subsequent Events**

 

On October 10, 2005,we announced that we had delivered a proposal to MTI to acquire all of theoutstanding shares of common stock of MTI that we do not already own. Wecurrently own approximately 70.1% of MTI’s outstanding common stock. On November 14,2005, we and MII entered into an Agreement and Plan of Merger with MTI pursuantto which we would acquire the shares of MTI that we do not already own at anexchange ratio of 0.476289 of a share of our common stock for each outstandingshare of MTI common stock. Under the terms of the merger, we would issueapproximately 6.9 million new shares of our common stock, bringing our totalpro forma outstanding shares to approximately 56.1 million. In addition, wewould assume all of the outstanding options to purchase MTI common stock underMTI’s stock option plans.  However, there

 

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can be no assurance thatthis transaction will be completed on these terms or at all.  As discussed in Note 16, on October 11,2005, a purported stockholder class action lawsuit related to our proposal toacquire all of the outstanding shares of MTI common stock, was filed in theCourt of Chancery of the State of Delaware.

 

On October 13,2005, MTI entered into a lease with The Irvine Company (the “Landlord”) forapproximately 96,400 square feet of new office, research and manufacturingspace located at 9775 Toledo Way, Irvine, CA 92618 (the “9775 Premises”).   The term of the lease is approximately fiveyears commencing on the date that the Landlord substantially completesimprovements to the 9775 Premises as set forth in the lease. The lease providesMTI with an option to extend the term of the lease for an additional six years.The basic rental amount for the 9775 Premises is initially $68 thousand permonth and increases annually over the term of the lease up to a maximum of $93thousand per month.

 

Inorder to provide MTI with financing to support the planned improvements andanticipated moving expenses, which are preliminarily estimated to beapproximately $2.3 million, we agreed to provide MTI with an unsecured loan upto $2.3 million.  MTI may draw downamounts under the loan from time to time up to an aggregate of $2.3 million.The amounts drawn down under the loan will bear interest at a floating primerate plus 2.3% and will be payable in 36 consecutive monthly installments, plusaccrued interest.  In addition to theloan, ev3 Endovascular issued a $1.0 million standby irrevocable letter ofcredit in favor of the Landlord, to provide MTI with additional financing tosupport the planned improvements. The letter of credit expires on September 15,2006, but will be automatically extended for successive one-year periodsthereafter, unless LaSalle Bank N.A. notifies the parties that it does notintend to renew the letter of credit for an additional year at least 30 daysprior to the expiration date, as such expiration date may be extended.

 

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| **ITEM 2.** | ** ** | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS** |
|-------------|------------|-------------------------------------------------------------------------------------------------|

 

Thefollowing management’s discussion and analysis of financial condition andresults of operations describes the principal factors affecting the results of ouroperations, financial condition and changes in financial condition for thethree and nine months ended October 2, 2005.  You should read this discussion together withthe accompanying unaudited consolidated financial statements, related notes andother financial information included herein. As discussed under the heading “Forward-LookingStatements” below, the following discussion and other portions of this reportmay contain predictions, estimates and other forward-looking statements thatinvolve a number of risks and uncertainties, including those discussed underthe heading «Risk Factors» below and elsewhere in this report. These riskscould cause our actual results to differ materially from any future performancesuggested in such forward-looking statements.

 

**Restatement**

 

Asdiscussed in Note 2 to our consolidated financial statements, in the course of finalizing ourconsolidated financial statements for the fiscal year ended December 31,2005, we determined that our consolidated statement of cash flows for the ninemonths ended October 2, 2005 should be restated to correct an error in theclassification of a $36.5 million payment of accrued interest on our demandnotes payable made in conjunction with the completion of our initial publicoffering on June 21, 2005.  The interestpayment was reported as a cash out-flow under “financing activities” and shouldhave been reported as a cash out-flow under “operating activities” undergenerally accepted accounting principles. The restatement does not affect thenet change in cash for the nine months ended October 2, 2005 and has noimpact on our consolidated balance sheet as of October 2, 2005, theconsolidated statement of operations and the related net loss per common shareattributable to common stockholders for the three and nine months ended October 2,2005 or the reported changes in stockholders’ equity (deficit) for the threeand nine months ended October 2, 2005. The “Liquidity and CapitalResources” section of this Management’s Discussion and Analysis ofFinancial Condition and Results of Operations has been updated to reflect thisrestatement.

 

**Overview**

 

We are a global medicaldevice company focused on catheter-based, or endovascular, technologies for theminimally invasive treatment of vascular diseases and disorders.  Our broad product portfolio is focused onapplications in each of the three sub-markets of the endovascular devicemarket: peripheral vascular, cardiovascular and neurovascular.  We sell over 100 products consisting of over1,000 SKUs in these markets.  From 2000to 2002, our investor group acquired certain of the assets in our cardioperipheral division to build the foundation of our current peripheral andcardiovascular product portfolios. During this period, our investor group alsopurchased certain neurovascular assets to expand our neurovascular productportfolio and, through a series of investments, obtained an indirectcontrolling investment in Micro Therapeutics, Inc., or MTI.  Beginning in 2002, we entered into long-term,exclusive agreements to market or distribute MTI’s full product portfolio inEurope, Japan, Canada and the major markets of Asia Pacific and LatinAmerica.  Since our last acquisition in2002, we have dedicated significant capital and management effort to advance ouracquired technologies and broaden our product lines in order to execute ourstrategies.

 

We have corporate infrastructure and direct salescapabilities in the United States, Canada, Europe and Japan and haveestablished distribution relationships in other large internationalmarkets.  Our corporate headquarters islocated in Plymouth, Minnesota and contains manufacturing, research anddevelopment, and U.S. sales operations for our peripheral vascular andcardiovascular product lines.  MTI isheadquartered in Irvine, California, which contains manufacturing, research anddevelopment, and U.S. sales operations for our neurovascular productlines.  Outside of the United States, ourprimary offices are located in Paris, France and Tokyo, Japan. During the threeand nine months ended October 2, 2005, approximately 43.0% and 47.0% of ournet sales, respectively, were generated outside of the United States, as aresult of which we are sensitive to risks related to fluctuation in exchangerates, which could affect our operating results in the future.

 

Since our inception, we have focused on building our U.S.and international direct sales and marketing infrastructure that included asales force of 198 direct sales representatives as of October 2, 2005 inthe United States, Canada, Europe and Japan. Direct sales representatives accounted for approximately 88.0% of our netsales during the three and the nine months ended October 2, 2005,respectively, with the balance generated by independent distributors.  In 2004,****weincreased our U.S. direct sales force from 44 to 82 and our Japan sales forcefrom four to eleven.  In order to drivesales growth, we have invested heavily throughout our history in new productdevelopment, clinical trials to obtain regulatory approvals and the expansionof our global distribution system.  As aresult, our costs and expenses have significantly exceeded our net sales,resulting in an accumulated deficit of $540.7 million at October 2,2005.  Consequently, we have financed ouroperations through debt and equity offerings. We expect to continue to generate operating losses for at least the next12 months.

 

Our cash,cash equivalents and short-term investments available to fund our currentoperations were $106.8 million and $20.1 million at October 2, 2005 and December 31,2004, respectively.  We completed aninitial public offering of our common stock on June 21, 2005 in which wesold 11,765,000 shares of our common stock at $14.00 per share, resulting innet proceeds to us of approximately $152.7 million, after deductingunderwriting discounts and commissions and offering expenses.  We used $36.5 million of these net proceedsto repay a portion of the accrued

 

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andunpaid interest on certain demand notes held by Warburg, Pincus EquityPartners, L.P. and certain of its affiliates, which we refer to collectively asWarburg Pincus, and The Vertical Group L.P. and certain of its affiliates,which we refer to collectively as Vertical. In addition, on July 20, 2005, we sold 205,800 shares of commonstock pursuant to an over-allotment option granted to the underwriters whichresulted in net proceeds to us of $2.2 million, after deducting underwritingdiscounts and commissions and offering expenses.  We invested the remaining portion of the netproceeds in short-term, investment-grade, interest bearing securities.  We expect to use these funds for generalcorporate purposes, which may include funding the operations of MTI.  We expect our cash balances to decrease as wecontinue to use cash to fund our operations. We do not have any debt forborrowed money. We believe our cash, cash equivalents and short-terminvestments will be sufficient to meet our liquidity requirements through theend of fiscal 2006.

 

We believe the overall market for endovascular deviceswill grow as the demand for minimally invasive treatment of vascular diseasesand disorders continues to increase. Our broad product portfolio is focused onapplications that we estimate represented an addressable worldwide endovascularmarket opportunity of approximately $1.6 billion in 2004. We intend tocapitalize on this market opportunity by the continued introduction of newproducts. We intend to originate these new products primarily through ourinternal research and development and clinical efforts, but we may supplementthem with acquisitions or other external collaborations. Additionally, ourgrowth has been, and will continue to be, impacted by our expansion into newgeographic markets and the expansion of our direct sales organization inexisting geographic markets.

 

We report and manage ouroperations in two reportable business segments based on similarities in theproducts sold, customer base and distribution system.  Our cardio peripheral segment containsproducts that are used in both cardiovascular and peripheral vascularprocedures by cardiologists, radiologists and vascular surgeons.  Our neurovascular segment contains productsthat are used primarily by neuro-radiologists and neurosurgeons.  Our sales activities and operations arealigned closely with our business segments. We generally have dedicated cardio peripheral sales teams in the UnitedStates and Europe that target customers who often perform procedures in bothanatomic areas (cardiovascular and peripheral vascular).  We generally have separate, dedicatedneurovascular sales teams in the United States and Europe that are specificallyfocused on this customer base.

 

MTI, our public operating subsidiary, is focused on theneurovascular market.  However, a smallportion of MTI’s sales relate to products sold into the cardio peripheralmarket, which we classify as cardio peripheral sales in our reporting.  In addition, some of MTI’s sales aregenerated at a transfer price to our international sales entities where theyare resold by our sales organization. For consolidated reporting, these intercompany sales areeliminated.  As a result, ourneurovascular sales will be different from the sales that MTI reportspublicly.  Based on MTI’s publicfinancial statements, approximately 42.1% of our net sales and 8.4% of our netlosses during the three months ended October 2, 2005 and 41.6% of our netsales and 4.5% of our net losses during the nine months ended October 2,2005 were attributable to MTI.

 

On January 28, 2005, ev3 Inc. was formed as asubsidiary of ev3 LLC.  Immediately priorto the closing of our initial public offering on June 21, 2005, ev3 LLCmerged with and into ev3 Inc., and ev3 Inc. became the holding company for allof ev3 LLC’s subsidiaries.  WarburgPincus and Vertical directly owned an aggregate of 9,704,819 shares of MTI’scommon stock, or 20.0% of the outstanding shares of MTI’s common stock as of May 1,2005. On May 26, 2005, pursuant to a contribution and exchange agreementdated as of April 4, 2005, Warburg Pincus and Vertical contributed theseshares of MTI’s common stock to ev3 LLC in exchange for 10,804,500 and3,004,332 common membership units of ev3 LLC, respectively, which wereconverted into 1,800,750 and 500,722 shares of our common stock, respectively,as a result of the merger described above and our one for six reverse stocksplit effected on June 21, 2005.  Asa result of the merger described above, as of October 2, 2005, we owned34,041,578 shares of MTI’s common stock, or 70.2% of the outstanding shares ofMTI’s common stock.

 

As thecontrolling stockholder, the contribution of the MTI shares by Warburg Pincus,representing a 15.7% interest in MTI as of May 26, 2005, was accounted foras a transfer of assets between entities under common control resulting in theretention of historical based accounting. Our consolidated financial statements included in this report giveeffect to the contribution of MTI shares owned by Warburg Pincus as though suchcontribution occurred in 2003 and 2004 when Warburg Pincus acquired itsinterest in MTI.  The contribution of theMTI shares owned by Vertical was accounted for under the purchase method ofaccounting on the contribution date. As of October 2, 2005 and December 31,2004, we owned 70.2% and 66.0% of the outstanding shares of common stock ofMTI,

 

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respectively.The following results of operations data include the financial results of MTI,which we consolidate for accounting purposes but is not wholly owned. Theconsolidation of MTI for accounting purposes results in all of MTI’s assets andliabilities being included in our consolidated balance sheets. Although all ofMTI’s assets are included in our consolidated balance sheets, not all of theseassets would be available to us for distribution to our stockholders in theevent of MTI’s liquidation.

 

Immediatelyprior to the consummation of our initial public offering, we completed aone-for-six reverse stock split of our outstanding common stock.  All share and per share amounts for allperiods presented in this report reflect this split.

 

On October 10, 2005,we announced that we had delivered a proposal to MTI to acquire all of theoutstanding shares of common stock of MTI that we do not already own. Wecurrently own approximately 70.1% of MTI’s outstanding common stock. On November 14,2005, we and MII entered into an Agreement and Plan of Merger with MTI pursuantto which we would acquire the shares of MTI that we do not already own at anexchange ratio of 0.476289 of a share of our common stock for each outstandingshare of MTI common stock. Under the terms of the merger, we would issueapproximately 6.9 million new shares of our common stock, bringing our totalpro forma outstanding shares to approximately 56.1 million. In addition, wewould assume all of the outstanding options to purchase MTI common stock underMTI’s stock option plans.

 

**Sales and Expense Components**

 

Thefollowing is a description of the primary components of our net sales andexpenses:

 

*Net sales.*    We derive our net sales fromthe sale of endovascular devices in two primary business segments: cardioperipheral and neurovascular devices. Most of our sales are generated by ourglobal, direct sales force and are shipped and billed to hospitals or clinicsthroughout the world. In countries where we do not have a direct sales force,sales are generated by shipments to distributors who, in turn, sell tohospitals and clinics. In cases where our products are held in consignment at acustomer’s location, we generate sales at the time the product is used insurgery rather than at shipment.  Wecharge our customers for shipping and record shipping income as part of netsales.

 

*Cost of goods sold.*    We manufacture a substantialmajority of the products that we sell.  Ourcost of goods sold consists primarily of direct labor, allocated manufacturingoverhead, raw materials, components and royalties and excludes amortization ofintangible assets, which is presented as a separate component of operatingexpenses.

 

*Sales, general and administrative expenses.*    Selling andmarketing expenses consist primarily of sales commissions and support costs forour global, direct distribution system and consulting expenses associated with ourmedical advisors, marketing costs, freight expense paid to ship products tocustomers and facility costs, including any costs related to closingfacilities. General and administrative expenses consist primarily of salariesand benefits, compliance systems, accounting, finance, legal, informationtechnology and human resources.

 

*Research and development.*    Research and developmentexpense includes costs associated with the design, development, testing,deployment, enhancement and regulatory approval of our products. It alsoincludes costs associated with design and execution of clinical trials andregulatory submissions.

 

*Amortization of intangible assets.*    Intangibleassets, such as purchased completed technology, distribution channels,intellectual property, including trademarks and patents, are amortized overtheir estimated useful lives. Intangible assets are amortized over periodsranging from 5 to 8 years.

 

*(Gain) loss on sale or disposal of assets, net.*    (Gain) loss on saleof assets, net includes the difference between the proceeds received from thesale of an operating asset and its carrying value.

 

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*Acquired in-process research and development.*    Acquiredin-process research and development is related to value assigned to thoseprojects acquired in business combinations or in the acquisition of assets forwhich the related products have not received regulatory approval and have noalternative future use.

 

*Gain on sale of investments, net.*    Gain on sale ofinvestments, net includes the difference between the proceeds received from thesale of an investment and its carrying value. In addition, this captionincludes losses from other than temporary declines in investments accounted foron a cost basis.

 

*Interest (income) expense, net.*    Interest (income)expense, net consists primarily of interest associated with loans from ourprincipal investors, Warburg Pincus and Vertical, and interest income earned oninvestments in investment-grade, interest-bearing securities.

 

*Minority interest in loss of subsidiary.*    Minority interestin loss of subsidiary is the portion of MTI’s net losses allocated to minoritystockholders.

 

*Other (income) expense, net.*    Other (income) expense, netprimarily includes foreign exchange losses net of certain other expenses.

 

*Income tax benefit.*    Income tax benefit isgenerated in certain of our European subsidiaries. Due to our history ofoperating losses, we have not recorded a provision for U.S. income taxesthrough 2004 and the nine months ended October 2, 2005.

 

*Accretion of preferred membership units to redemption value.*    Accretion ofpreferred membership units to redemption value represents the increase incarrying value of preferred membership units of ev3 LLC prior to ev3 LLC’smerger with and into us on June 21, 2005. The increase in carrying value was based on the rights to which thepreferred membership units were entitled related to a liquidation, dissolutionor winding up of ev3 LLC. Accretion was recorded as a reduction to members’equity and increased the loss attributable to common unit holders. Accretionwas discontinued upon conversion of the preferred units to common membershipunits, and subsequently into shares of our common stock, on June 21, 2005,in connection with the merger.

 

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**Results of Operations**

 

Thefollowing table sets forth, for the periods indicated, our results ofoperations expressed as dollar amounts (in thousands), and the changes betweenthe specified periods expressed as percent increases or decreases:

 
| ** **                                                                         | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                                                                         | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **Percent  Change** | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **Percent  Change** | ** ** |
|                                                                               |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Net sales                                                                          |       | $                         | 33,500     |                      | $          | 19,654 |   | 70.4 | % | $ | 92,722 |   | $ | 60,803 |   | 52.5 | % |
|                                                                               |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Operating expenses                                                                 |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Cost of goods sold (a)                                                             |       | 13,590                    |       | 9,327                     |       | 45.7 | % | 38,484 |   | 27,484 |   | 40.0 | % |
| Sales, general and administrative (a)                                              |       | 30,666                    |       | 24,003                    |       | 27.8 | % | 94,823 |   | 71,960 |   | 31.8 | % |
| Research and development (a)                                                       |       | 8,436                     |       | 10,577                    |       | (20.2 | )% | 30,653 |   | 30,320 |   | 1.1 | % |
| Amortization of intangible assets                                                  |       | 2,674                     |       | 2,438                     |       | 9.7 | % | 7,877 |   | 7,416 |   | 6.2 | % |
| (Gain) loss on sale or disposal of assets, net                                     |       | 40                        |       | (14,514                   | )          | NM |   | 204 |   | (14,495 | ) | NM |   |
| Acquired in-process research and development                                       |       | —                    |       | —                    |       | NM |   | 868 |   | — |   | NM |   |
| Total operating expenses                                                           |       | 55,406                    |       | 31,831                    |       | 74.1 | % | 172,909 |   | 122,685 |   | 40.9 | % |
|                                                                               |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Loss from operations                                                               |       | (21,906                   | )          | (12,177                   | )          | 79.9 | % | (80,187 | ) | (61,882 | ) | 29.6 | % |
|                                                                               |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Other (income) expense:                                                            |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Gain on sale of investments, net                                                   |       | —                    |       | —                    |       | NM |   | (4,611 | ) | (1,728 | ) | 166.8 | % |
| Interest (income) expense, net                                                     |       | (953                      | )          | 9,802                     |       | NM |   | 10,833 |   | 20,415 |   | (46.9 | )% |
| Minority interest in loss of subsidiary                                            |       | (486                      | )          | (6,910                    | )          | (93.0 | )% | (1,212 | ) | (11,982 | ) | (89.9 | )% |
| Other (income) expense, net                                                        |       | (8                        | )          | 213                       |       | NM |   | 2,912 |   | 319 |   | NM |   |
| Loss before income taxes                                                           |       | (20,459                   | )          | (15,282                   | )          | 33.9 | % | (88,109 | ) | (68,906 | ) | 27.9 | % |
| Income tax benefit                                                                 |       | (2                        | )          | —                    |       | NM |   | (61 | ) | — |   | NM |   |
|                                                                               |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Net loss                                                                           |       | (20,457                   | )          | (15,282                   | )          | 33.9 | % | (88,048 | ) | (68,906 | ) | 27.8 | % |
|                                                                               |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Accretion of preferred membership units to  redemption value (b)                   |       | —                    |       | 5,988                     |       |   |   | 12,061 |   | 17,792 |   |   |   |
|                                                                               |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Net loss attributable to common stockholders                                       |       | $                         | (20,457    | )                         | $          | (21,270 | ) | (3.8 | )% | $ | (100,109 | ) | $ | (86,698 | ) | 15.5 | % |
|                                                                               |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Net loss per common share attributable to common  stockholders (basic and diluted) |       | $                         | (0.42      | )                         | $          | (8.35 | ) |   |   |   |   | $ |  (4.99 | ) | $ |  (43.07 | ) |
|                                                                               |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Weighted average common shares outstanding                                         |       | 49,099,357                |       | 2,547,809                 |       |   |   |   |   | 20,069,139 |   | 2,012,829 |   |
|                                                                                    |            |                           |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| (a) Includes stock based compensation charges  of: |   |   |   |   |   |   |   |   |   |   |   |   |   |
|---------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Cost of goods sold                                      |   | $      | 198    |   | $      | 45     |   |   |   | $      | 445    |   | $      | 143 |   |   |   |
| Sales, general and administrative                       |   | 859    |   | 192    |   |   |   | 1,904  |   | 1,565  |   |   |   |
| Research and development                                |   | 295    |   | 179    |   |   |   | 729    |   | 577    |   |   |   |
|                                                    |   | $      | 1,352  |   | $      | 416    |   |   |   | $      | 3,078  |   | $      | 2,285 |   |   |   |

 

(b)            Theaccretion of preferred membership units to redemption value presented above isbased on the rights to which the Class A and Class B preferredmembership unit holders of ev3 LLC were entitled related to a liquidation,dissolution or winding up of ev3 LLC. Notwithstanding this accretion right, inconnection with the merger of ev3 LLC with and into us, each membership unitrepresenting a preferred equity interest in ev3 LLC was converted into theright to receive one share of our common stock and did not receive anyadditional rights with respect to the liquidation preference.  As a result, no further accretion related tothese preferred units will be recorded.

 

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Thefollowing tables set forth, for the periods indicated, our net sales by segmentand geography expressed as dollar amounts (in thousands) and the changes in netsales between the specified periods expressed as percentages:

 
| ** **                          | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|-------------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                          | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **Percent  Change** | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **Percent  Change** | ** ** |
| **NET  SALES BY SEGMENT**           |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| ** **                          |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Cardio Peripheral                   |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Stents                              |       | $                         | 9,913      |                      | $          | 4,772 |   | 107.7 | % | $ | 25,792 |   | $ | 14,777 |   | 74.5 | % |
| Thrombectomy and embolic protection |       | 2,949                     |       | 1,748                     |       | 68.7 | % | 9,410 |   | 5,683 |   | 65.6 | % |
| Procedural support and other        |       | 6,981                     |       | 5,528                     |       | 26.3 | % | 20,690 |   | 17,320 |   | 19.5 | % |
| Total Cardio Peripheral             |       | $                         | 19,843     |                      | $          | 12,048 |   | 64.7 | % | $ | 55,892 |   | $ | 37,780 |   | 47.9 | % |
|                                |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Neurovascular                       |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Embolic products                    |       | 6,220                     |       | 2,850                     |       | 118.2 | % | 14,417 |   | 8,337 |   | 72.9 | % |
| Neuro access and delivery products  |       | 7,437                     |       | 4,756                     |       | 56.4 | % | 22,413 |   | 14,686 |   | 52.6 | % |
| Total Neurovascular                 |       | $                         | 13,657     |                      | $          | 7,606 |   | 79.6 | % | $ | 36,830 |   | $ | 23,023 |   | 60.0 | % |
|                                |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Total net sales                     |       | $                         | 33,500     |                      | $          | 19,654 |   | 70.4 | % | $ | 92,722 |   | $ | 60,803 |   | 52.5 | % |

 
| ** **                     | ** ** | **Three Months Ended**    | ** ** | **Nine Months Ended**     | ** ** |
|--------------------------------|------------|---------------------------|------------|---------------------------|------------|
| ** **                     | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **Percent  Change** | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** | **Percent  Change** | ** ** |
| **NET SALES BY GEOGRAPHY**     |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| ** **                     |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| United States                  |       | $                         | 19,081     |                      | $          | 10,178 |   | 87.5 | % | $ | 49,141 |   | $ | 30,888 |   | 59.1 | % |
| International                  |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Before foreign exchange impact |       | 14,455                    |       | 9,476                     |       | 52.5 | % | 42,667 |   | 29,915 |   | 42.6 | % |
| Foreign exchange impact        |       | (36                       | )          | —                    |       | — |   | 914 |   | — |   | — |   |
| Total                          |       | 14,419                    |       | 9,476                     |       | 52.2 | % | 43,581 |   | 29,915 |   | 45.7 | % |
|                           |       |                      |       |                      |       |   |   |   |   |   |   |   |   |
| Total net sales                |       | $                         | 33,500     |                      | $          | 19,654 |   | 70.4 | % | $ | 92,722 |   | $ | 60,803 |   | 52.5 | % |

 

***Comparison of the Three Months Ended October 2, 2005 tothe Three Months Ended October 3, 2004***

 

*Net sales.*    Net sales increased 70.4% to$33.5 million in the three months ended October 2, 2005 compared to $19.7million in the three months ended October 3, 2004, primarily as a resultof continued unit sales growth in the 25 new product introductions since October 1,2004 and the expansion of our distribution system. We increased our U.S. directsales force from 44 persons at the beginning of 2004 to 82 persons at thebeginning of 2005, with most of the growth occurring in the fourth quarter of2004. The sales force expansion was primarily to support new productintroductions that began in late 2004 and have continued in 2005. We introduced19 new products in the first half of 2005 and 2 new products in the thirdquarter of 2005.  We expect to introduceadditional new products during the remainder of the year.

 

*Net sales of cardio peripheralproducts.*    Net sales of our cardioperipheral products increased 64.7% to $19.8 million in the three months ended October 2,2005 compared to $12.0 million in the three months ended October 3, 2004.This sales growth was primarily the result of new product introductions and theexpansion of our U.S. direct sales force in the fourth quarter of 2004 asdescribed above, partially offset by sales declines in older generationproducts. Key new product launches since the third quarter of 2004 thatcontributed to the sales increase for the three months ended October 2,2005 included the Protégé stents, Primus stents, Invatec percutaneoustransluminal angioplasty, or PTA, balloon catheters, the SpideRX embolicprotection system, the Diver C.E. aspiration catheter and ParaMount Ministents.

 

Netsales in our stent product line increased 107.7% to $9.9 million in the threemonths ended October 2, 2005 compared to $4.8 million in the three monthsended October 3, 2004. This increase is attributable to the introductionof the Protégé, Primus and ParaMount Mini families of stents into the U.S. andinternational markets during the

 

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previous twelve months,partially offset by sales declines in older generation products. Net sales ofour thrombectomy and embolic protection devices increased 68.7% to$2.9 million in the three months ended October 2, 2005 compared tothe three months ended October 3, 2004 largely due to the introduction ofthe SpideRX internationally and the introduction of the X-Sizer in the UnitedStates in late 2004, partially offset by sales declines in older generationproducts.  Net sales in our proceduralsupport and other product lines increased 26.3% to $7.0 million in the threemonths ended October 2, 2005 compared to $5.5 million in the three monthsended October 3, 2004.  Thisincrease is primarily attributable to the increase in sales of our PTA balloonswhich were launched early in 2005.  Weexpect our cardio peripheral net sales to increase during the remainder of 2005primarily as a result of introducing several new products during the year,especially in our stent family, and continued market penetration from ourrecently expanded sales force.

 

*Net sales ofneurovascular products.*    Net sales of our neurovascular products increased79.6% to $13.7 million in the three months ended October 2, 2005 comparedto $7.6 million in the three months ended October 3, 2004, primarily as aresult of U.S. Food and Drug Administration (FDA) approval and the UnitedStates launch of the Onyx liquid embolic system for the treatment of brainarterio-venous malformations (“AVM’s”) on July 21, 2005.  Also contributing are volume increases in theNXT family of embolic coils and continued penetration by microcatheters andocclusion balloon systems. We experienced a $3.4 million, or 118.2%,  increase in net sales of our embolic productsin the three months ended October 2, 2005 compared to the same period in2004 primarily due to the July 2005 U.S. launch of the Onyx liquid embolicsystem for the treatment of brain AVM’s and volume increases in sales of theNXT coil family. Net sales of our neuro access and delivery products increased56.4% to $7.4 million in the three months ended October 2, 2005 comparedto the three months ended October 3, 2004 due primarily to volumeincreases across multiple product lines, including the Marathon microcatheter,the Echelon microcatheters, and the HyperForm and HyperGlide occlusionballoon systems.

 

*Net sales bygeography.*    Netsales in the United States increased 87.5% to $19.1 million in the three monthsended October 2, 2005 compared to $10.2 million in the three months ended October 3,2004. International net sales increased 52.2% to $14.4 million in the threemonths ended October 2, 2005 compared to $9.5 million in the three monthsended October 3, 2004 and represented 43.0% of company-wide sales in thethree months ended October 2, 2005 compared to 48.2% in the three monthsended October 3, 2004. The effects of currency on our international netsales in the three months ended October 2, 2005 were negligible comparedto the three months ended October 3, 2004. Company-wide, 88.0% of netsales were generated by direct sales operations during the three months ended October 2,2005 compared to 87.0% in the comparable period of 2004.  Direct sales force operations in Europecontributed $2.7 million, or 53.8%, of the total international net salesgrowth.

 

*Cost ofgoods sold.*    Costof goods sold increased 45.7% to $13.6 million in the three months ended October 2,2005 compared to $9.3 million in the three months ended October 3, 2004 asa result of increased sales, as discussed above. As a percentage of net sales,cost of goods sold decreased to 40.6% in the three months ended October 2,2005 compared to 47.5% in the three months ended October 3, 2004. Thisdecrease was primarily attributable to increased production volumes andin-house manufacturing of certain stent components.  In our cardio peripheral segment, cost ofgoods sold as a percentage of net sales decreased to 47.9% in the three monthsended October 2, 2005 compared to 51.8% in the three months ended October 3,2004.  This decrease was due primarily toleveraging fixed costs relative to higher sales and increased productionvolumes and moving the manufacturing of certain stent components in-house. Inour neurovascular segment, cost of goods sold as a percentage of net salesdecreased to 30.0% in the three months ended October 2, 2005 compared to40.5% in the three months ended October 3, 2004 due primarily toleveraging fixed costs relative to higher sales and increased productionvolumes. We expect cost of goods sold as a percentage of net sales to continueto decline during 2005 due to higher volume in our manufacturing facilities andefficiency improvements from manufacturing initiatives.

 

*Sales,general and administrative expense.*    Sales, general and administrative expense increased27.8% to $30.7 million in the three months ended October 2, 2005 comparedto $24.0 million in the three months ended October 3, 2004. This increasewas due to a $5.6 million increase in selling expenses primarily relatedto the increase in our U.S. direct sales force described above and an increasein expenses related to expanding our international sales presence, a$1.1 million increase in legal expenses in the cardio peripheral segmentand a $500 thousand increase in general and administrative expenses, partiallyoffset by a $500 thousand reduction in legal expenses in the

 

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neurovascular segment.  We expect sales, general and administrativeexpenses to continue to decline as a percentage of net sales as we believe thatour current infrastructure can support a higher level of sales.

 

*Research anddevelopment.*    Researchand development expense decreased 20.2% to $8.4 million in the three monthsended October 2, 2005 compared to $10.6 million in the three months ended October 3,2004. This decrease was primarily due to a $3.3 million reduction in clinicaltrial expenses primarily in our cardio peripheral segment, partially offset bya $1.3 million increase in product development expenses primarily in our cardioperipheral segment.  The remaining $200thousand decrease was due to reductions in other research and developmentexpenses. Research and development expense, as a percentage of net sales,decreased to 25.2% for the three months ended October 2, 2005 from 53.8%for the three months ended October 3, 2004.  We expect research and development spendingto decline as a percentage of net sales as the enrollment in several clinicaltrials was completed during the third quarter of 2005.

 

*Amortizationof intangible assets.*    Amortizationof intangible assets increased 9.7% to $2.7 million in the three months ended October 2,2005 compared to $2.4 million in the three months ended October 3,2004.  This increase was primarily aresult of additional amortizable intangible assets related to Vertical’s May 26,2005 contribution to ev3 LLC of shares of MTI. This contribution was accountedfor under the purchase method of accounting based upon the proportionateownership contributed to ev3 LLC and resulted in an increase in amortizableintangible assets of approximately $3.4 million.

 

*(Gain) losson sale or disposal of assets, net.*    We incurred a loss on sale or disposal of assets of$40 thousand in the three months ended October 2, 2005.  In the three months ended October 3,2004, we recognized a gain on sale or disposal of assets of $14.5 millionresulting from the sale of intellectual property obtained in the MitraLifeacquisition.

 

*Loss fromoperations.*    Our loss from operations increased 79.9% to$21.9 million for the three months ended October 2, 2005 compared with $12.2million for the three months ended October 3, 2004.  Our loss from operations decreased $4.8million, or 17.9%, from the third quarter of 2004 when considering the $14.5million gain on sale of intellectual property, noted above, realized in thethird quarter of 2004.

 

*Interest(income) expense, net.*    Werecognized interest income of $1.0 million in the three months ended October 2,2005 related to investing the net proceeds received from our initial publicoffering in June 2005.  Also inconnection with our initial public offering in June 2005, our demand noteswere converted to common stock and are no longer incurring interestexpenses.  In the three months ended October 3,2004, we incurred interest expense, net of $9.8 million, which consisted of$5.0 million of interest expense related to the outstanding debt balance duringthe third quarter and a $4.8 million charge related to a beneficialconversion feature arising from the minority interests’ participation in twofinancings of MTI during 2004.

 

*Minorityinterest in loss of subsidiary.*    Minority interest in loss of subsidiary, whichrepresents the portion of MTI’s losses allocated to minority investors, was$500 thousand in the three months ended October 2, 2005 compared to $6.9million in the three months ended October 3, 2004. This decrease was dueprimarily to lower losses at MTI in the three months ended October 2, 2005compared to the three months ended October 3, 2004.

 

*Other(income) expense, net*.   Other (income) expense, net was immaterialin the three months ended October 2, 2005 and October 3, 2004.

 

*Income taxbenefit.*   We incurred a modest income tax benefit in the three months ended October 2,2005 related to certain of our European sales offices and incurred no incometax expense or benefit in the three months ended October 3, 2004.    We recorded no income tax provision forU.S. income taxes in the three months ended October 2, 2005 or October 3,2004 due to our history of operating losses.

 

*Accretion ofpreferred membership units to redemption value.*    We did not incuraccretion of preferred membership units in the three months ended October 2,2005 compared to $6.0 million in the three months ended October 3, 2004due to the conversion of the preferred membership units into common membershipunits, and subsequently

 

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into shares of common stock,on June 21, 2005 in conjunction with the merger of ev3 LLC with and intous immediately prior to our initial public offering.  Accretion was discontinued upon conversion ofthe preferred units to common membership units on June 21, 2005.

 

***Comparison of the Nine Months Ended October 2,2005 to the Nine Months Ended October 3, 2004***

 

*Net sales.*    Net sales increased52.5% to $92.7 million in the nine months ended October 2, 2005compared to $60.8 million in the nine months ended October 3, 2004,primarily as a result of new product introductions and the expansion of ourdistribution system during 2004. Our U.S. direct sales force was increased from44 persons at the beginning of 2004 to 82 persons at the beginning of 2005 withmost of the growth occurring in the fourth quarter of 2004. The sales forceexpansion was primarily to support new product introductions that began in late2004 and continued in the first, second, and third quarters of 2005. Weintroduced 19 new products in the first half of 2005 and 2 new products in thethird quarter of 2005.

 

*Net sales ofcardio peripheral products.*    Net sales of our cardio peripheral products increased47.9% to $55.9 million in the nine months ended October 2, 2005compared to $37.8 million in the nine months ended October 3, 2004.This sales growth was primarily the result of new product introductions and theexpansion of our U.S. sales force in the fourth quarter of 2004 as describedabove, partially offset by sales declines in older generation products. Key newproduct launches that contributed to the sales increase for the nine monthsended October 2, 2005 included the Protégé stents, Primus stents, PTAballoon catheters, SpideRX embolic protection system, the X-Sizer thrombectomycatheter, the Diver C.E. aspiration catheter and ParaMount Mini stents.  Net sales in our stent product line increased74.5% to $25.8 million in the nine months ended October 2, 2005compared to $14.8 million in the nine months ended October 3, 2004.This increase is attributable to the introduction of the Protégé, Primus andParaMount Mini families of stents into the U.S. and international marketsduring 2004, partially offset by sales declines in older generation products.Net sales of our thrombectomy and embolic protection devices increased 65.6% to$9.4 million in the nine months ended October 2, 2005 compared to thenine months ended October 3, 2004 largely due to the introduction of theSpideRX internationally and the introduction of the X-Sizer in the UnitedStates in late 2004, partially offset by sales declines in older generationproducts.  Net sales of our proceduralsupport and other products increased 19.5% to $20.7 million in the nine monthsended October 2, 2005 compared to the nine months ended October 3,2004, largely due to the introduction of PTA balloon catheters in early 2005.

 

*Net sales ofneurovascular products.*    Net sales of our neurovascular products increased60.0% to $36.8 million in the nine months ended October 2, 2005compared to $23.0 million in the nine months ended October 3, 2004,primarily as a result of volume increases in the NXT family of embolic coilsand continued penetration by our microcatheters and occlusion balloonsystems.   Also contributing are theUnited States launch and FDA approval of the Onyx liquid embolic system for thetreatment of brain AVM’s on July 21, 2005 and volume increases in the Onyxembolic liquids internationally.  Netsales of our neuro access and delivery products increased 52.6% to $22.4million in the nine months ended October 2, 2005 compared to the ninemonths ended October 3, 2004 largely as a result of volume increasesacross multiple product lines, including the Echelon microcatheters, theMarathon microcatheter, and the HyperForm and HyperGlide occlusion balloonsystems.  Net sales of our embolicproducts increased 72.9% to $14.4 million in the nine months ended October 2,2005 compared to the nine months ended October 3, 2004 primarily due tothe July 2005 U.S. launch of the Onyx liquid embolics for the treatment ofbrain AVM’s, volume increases in the Onyx liquid embolics internationally andvolume increases in the NXT family of embolic coils,.

 

*Net sales bygeography.*    Netsales in the United States increased 59.1% to $49.1 million in the ninemonths ended October 2, 2005 compared to $30.9 million in the ninemonths ended October 3, 2004. International net sales increased 45.7% to$43.6 million in the nine months ended October 2, 2005 compared to$29.9 million in nine months ended October 3, 2004 and represented47.0% of company-wide net sales in the nine months ended October 2, 2005compared to 49.2% in the nine months ended October 3, 2004.  International net sales for the nine monthsended October 2, 2005 include a favorable currency impact of approximately2.1%, or $900 thousand, compared to the nine months ended October 3, 2004,principally resulting from the performance of the Euro against the U.S.dollar.   Our direct sales forceoperations in Europe contributed $8.5 million, or 62.0%, of the totalinternational net sales growth, with the remainder coming from our distributionoperations in the Asia Pacific markets and our direct

 

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sales force operations inJapan.  The sales growth in ourinternational markets was primarily a result of new product introductions andincreased penetration.

 

*Cost ofgoods sold*.    Costof goods sold increased 40.0% to $38.5 million in the nine months ended October 2,2005 compared to $27.5 million in the nine months ended October 3,2004 primarily as a result of increased sales, as discussed above. As apercentage of net sales, cost of goods sold decreased to 41.5% in the ninemonths ended October 2, 2005 compared to 45.2% in the nine months ended October 3,2004. This decrease was primarily attributable to initiatives in ourneurovascular segment.   In our cardioperipheral segment, cost of goods sold as a percentage of net sales increasedto 47.5% in the nine months ended October 2, 2005 compared to 46.7% in thenine months ended October 3, 2004, primarily due to production scrap andother start up costs related to the introduction of new products.  In our neurovascular segment, cost of goodssold as a percentage of net sales decreased to 32.4% in the nine months ended October 2,2005 compared to 42.8% in the nine months ended October 3, 2004 due toincreased production volumes.

 

*Sales,general and administrative expense.*    Sales, general and administrative expense increased31.8% to $94.8 million in the nine months ended October 2, 2005compared to $72.0 million in the nine months ended October 3, 2004.This increase was due to a $17.6 million increase in selling expensesprimarily related to the increase in the U.S. direct sales force describedabove and an increase in expenses related to expanding our international salespresence, a $5.3 million increase in general and administrative expenses, a$2.4 million increase in marketing and distribution expenses and a $1.0million increase in legal expenses in our cardio peripheral segment, partiallyoffset by $3.4 million reduction in legal expenses in our neurovascularsegment.

 

*Research anddevelopment.*    Researchand development expense increased 1.1% to $30.7 million in the nine monthsended October 2, 2005 compared to $30.3 million in the nine monthsended October 3, 2004.  Thisincrease was primarily due to a $2.7 million increase in product developmentexpenses, partially offset by a $2.2 million reduction in clinical expensesrelated to the completion of certain clinical trials.  Research and development expenses, as apercentage of net sales, decreased to 33.1% for the nine months ended October 2,2005 from 49.9% for the nine months ended October 3, 2004.

 

*Amortizationof intangible assets.*    Amortizationof intangible assets increased 6.2% to $7.9 million in the nine monthsended October 2, 2005 compared to $7.4 million in the nine monthsended October 3, 2004. This increase was primarily a result of additionalamortizable intangible assets related to Vertical’s May 26, 2005contribution to ev3 LLC of shares of MTI. This contribution was accounted forunder the purchase method of accounting based upon the proportionate ownershipcontributed to ev3 LLC and resulted in an increase in the amortizableintangible assets of approximately $3.4 million.

 

*(Gain) losson sale or disposal of assets, net.*    We incurred a loss on sale or disposal of assets of$200 thousand in the nine months ended October 2, 2005.  In the nine months ended October 3,2004, we recognized a gain on sale or disposal of assets of $14.5 millionresulting from the sale of intellectual property obtained in the MitraLifeacquisition.

 

*Acquiredin-process research and development.*    During the nine months ended October 2, 2005,we incurred a charge of $868 thousand for acquired in-process research anddevelopment as a result of Vertical’s contribution to ev3 LLC of shares ofMTI.  This contribution was accounted forunder the purchase method of accounting based upon the proportionate ownershipcontributed to ev3 LLC.  For a discussionof this amount, see Note 6 to the unaudited consolidated financial statementsincluded in this report.  We did notincur charges for acquired in-process research and development expense duringthe nine months ended October 3, 2004.

 

*Gain on saleof investments, net.*    Gainon sale of investments, net was $4.6 million in the nine months ended October 2,2005 compared to $1.7 million in the nine months ended October 3,2004. During the nine months ended October 2, 2005, we received a $3.7million milestone payment related to the sale of our investment in GenyxMedical, Inc. and received a $900 thousand milestone payment relating toour 2002 sale of our investment in Enteric Medical Technologies, Inc.  During the nine months ended October 3,2004, we received a $1.7 milestone payment relating to our 2002 sale of ourinvestment in Enteric Medical Technologies, Inc.

 

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*Loss fromoperations.*    Our loss from operations increased 29.6% to $80.2million for the nine months ended October 2, 2005 compared with $61.9million for the nine months ended October 3, 2004.  Our loss from operations increased $3.8million, or 5.0%, from the nine months ended October 3, 2004 whenconsidering the $14.5 million gain on sale of intellectual property, notedabove, realized in the third quarter of 2004.

 

*Interest(income) expense, net.*    Interest(income) expense, net decreased 46.9% to $10.8 million in the nine monthsended October 2, 2005 compared to $20.4 million for the nine monthsended October 3, 2004.  Interest(income) expense, net decreased by $9.6 million due to several factors.  During the first nine months of 2004, werecorded a $6.8 million charge related to beneficial conversion featuresarising from the minority interests’ participation in two financings of MTIduring 2004 which did not re-occur during 2005. Our outstanding debt balance was converted into common stock inconnection with our initial public offering in June 2005, which resultedin a $1.8 million decrease in interest expense.   We generated approximately $1.0 million ofinterest income during the third quarter of 2005 from investing the netproceeds of our initial public offering in June 2005.

 

*Minorityinterest in loss of subsidiary.*    Minority interest in loss of subsidiary, whichrepresents the portion of MTI’s losses allocated to minority investors, was$1.2 million in the nine months ended October 2, 2005 and$12.0 million in the nine months ended October 3, 2004.  This decrease was primarily due to lowerlosses at MTI in the nine months ended October 2, 2005 compared to thenine months ended October 3, 2004.

 

*Other (income)expense, net.*    Other(income) expense, net was $2.9 million in the nine months ended October 2,2005 compared to $300 thousand in the nine months ended October 3, 2004.This increase was primarily related to increases in foreign exchange losses inthe nine months ended October 2, 2005 compared to the nine months ended October 3,2004.

 

*Income taxbenefit.*    Weincurred a modest income tax benefit in the nine months ended October 2,2005 related to certain of our European sales offices and incurred no incometax expense or benefit in the nine months ended October 3, 2004.  We recorded no provision for U.S. incometaxes in the nine months ended October 2, 2005 or the nine months ended October 3,2004 due to our history of operating losses.

 

*Accretion ofpreferred membership units to redemption value.*    Accretion of preferredmembership units to redemption value decreased 32.2% to $12.1 million inthe nine months ended October 2, 2005 compared to $17.8 million inthe nine months ended October 3, 2004 due to the conversion of thepreferred membership units into common membership units, and subsequently intoshares of common stock, on June 21, 2005 in connection with the merger ofev3 LLC with and into us immediately prior to our initial public offering.   Accretion was discontinued upon conversionof the preferred units to common membership units on June 21, 2005.

 

**Liquidity andCapital Resources**

 

*Financinghistory.*    Sinceinception, we have generated significant operating losses. These operatinglosses, including cumulative non-cash charges for acquired in-process researchand development of $127 million, have resulted in an accumulated deficit of$540.7 million as of October 2, 2005. Historically, our liquidity needsand the liquidity needs of MTI have been met separately. In general, MTI hasbeen funded through equity private placements and the issuance of promissorynotes, while we have been funded through a series of preferred investments, theissuance of demand notes to private investors and most recently an initialpublic offering of our common stock.  Thefollowing provides a discussion of our liquidity and capital resourcesincluding MTI, followed by a brief discussion of the liquidity and capitalresources of MTI on an independent basis.

 

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*Cash, cashequivalents and short-term investments.*    As of October 2,2005, we had cash, cash equivalents and short-term investments of $106.8million.

 
| **Balance Sheet Data**                     | ** ** | **As of October 2,  2005** | ** ** | **As of December 31,  2004** | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|-----------------------------------|------------|
| **(in thousands)**                         | ** ** | ** **                      | ** ** | ** **                        | ** ** |
| ** **                                 | ** ** | ** **                      | ** ** | ** **                        | ** ** |
| Cash and cash equivalents                  |       | $                               | 94,762     |                              | $          | 20,131 |   |
| Short term investments                     |       | 12,010                          |       | —                            |       |
| Current assets                             |       | 168,548                         |       | 68,609                            |       |
| Total assets                               |       | 314,554                         |       | 212,046                           |       |
| Current liabilities excluding demand notes |       | 35,999                          |       | 36,025                            |       |
| Demand notes payable—related parties  |       | —                          |       | 299,453                           |       |
| Total liabilities                          |       | 36,481                          |       | 336,180                           |       |
| Preferred membership units                 |       | —                          |       | 254,028                           |       |
| Total stockholders’ equity (deficit)  |       | $                               | 264,744    |                              | $          | (394,472 | ) |

 

*Contractualcash obligations.*    AtOctober 2, 2005, we had contractual cash obligations and commercialcommitments as follows:

 
| ** **              | ** ** | **Payments  Due by Period** | ** ** |
|-------------------------|------------|-----------------------------|------------|
| ** **              | ** ** | **Total**                   | ** ** | **Less  than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More  than  5 Years** | ** ** |
| ** **              | ** ** | **(dollars  in thousands)** | ** ** |
|                    |       |                        |       |   |   |   |   |   |   |   |   |
| Purchase commitments(1) |       | $                           | 48,267     |   | $ | 13,564 |   | $ | 34,703 |   | $ | — |   | $ | — |   |
| Operating leases(2)     |       | 10,097                      |       | 3,542 |   | 4,363 |   | 2,131 |   | 61 |   |
|                    |       |                        |       |   |   |   |   |   |   |   |   |
| Total                   |       | $                           | 58,364     |   | $ | 17,106 |   | $ | 39,066 |   | $ | 2,131 |   | $ | 61 |   |

 

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(1)          Represents commitments for minimum inventorypurchases related to our distribution agreement with Invatec S.r.l. We do nothave any other significant purchase obligations for the delivery of goods orservices or other commercial commitments.

 

(2)          The amounts reflected in the table above foroperating leases represent future minimum lease payments under non-cancelableoperating leases primarily for certain office space, warehouse space, computersand vehicles. Portions of these payments are denominated in foreign currenciesand were translated in the tables above based on their respective U.S. dollarexchange rates at October 2, 2005. These future payments are subject toforeign currency exchange rate risk. In accordance with U.S. generally acceptedaccounting principles, or GAAP, operating leases are not recognized in ourconsolidated balance sheet.

 

*Operatingactivities.    *Cash used in operations during the nine months ended October 2, 2005was $110.8 million, reflecting primarily the net losses, the changein accrued interest resulting from our repaymentof $36.5 million of accrued and unpaid interest on demand notes payable inconjunction with the completion of our initial public offering on June 21,2005, and increased working capitalrequirements during the period.  Thisusage was partially offset by non-cash charges for depreciation andamortization. Our net loss also reflected $4.6 million of gain recognized onthe sale of investments, as discussed below. The increases in accounts receivable and inventories during the ninemonths ended October 2, 2005 were related to increases in sales volumeduring the period.  The change inaccrued interest is related to our repayment of $36.5 million of accrued andunpaid interest on demand notes payable. We expect that operations willcontinue to use cash during the remainder of 2005.

 

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*Investingactivities.    *Cash used in investing activities during the nine months ended October 2,2005 was $19.8 million primarily due to the investment of $12.0 million inshort-term investment-grade securities, the purchase of $9.9 million ofproperty and equipment and a $3.7 million milestone payment related to aprevious acquisition.  The net use ofcash from investing activities was reduced by the receipt of $3.7 millionfrom the sale of certain assets by Genyx Medical, Inc., in which MTI holdsa minority interest, the receipt of $2.1 million in a settlement of anacquisition dispute and the receipt of a $900 thousand milestone paymentrelated to our 2002 sale of our investment in Enteric Medical Technologies, Inc.Historically, our capital expenditures have consisted of purchasedmanufacturing equipment, research and testing equipment, computer systems andoffice furniture and equipment.  Wecontinue to make investments in property and equipment and expect to incur anadditional $6.0 million in capital expenditures during the balance of 2005.

 

*Financingactivities.    *Cash provided by financing activities was $205.2 million during thenine months ended October 2, 2005, consisting of $154.9 million of net proceedsreceived from the initial public offering of our common stock, inclusive of theunderwriters’ exercise of their over-allotment option on July 20, 2005,and proceeds of $49.1 million from the issuance of demand notes.

 

*Otherliquidity information.*

 

On July 20, 2005, we sold205,800 shares of common stock pursuant to the over-allotment option granted tothe underwriters in connection with our initial public offering.  Net proceeds to us from this sale totaled$2.2 million, after deducting underwriting discounts and commissions andoffering expenses.

 

On October 13, 2005, MTIentered into a lease for new office, research and manufacturing space.  In order to provide MTI with financing tosupport planned facility improvements and anticipated moving expenses, weagreed to provide MTI up to $2.3 million in an unsecured loan and ev3Endovascular, Inc., our wholly owned subsidiary, has entered into a $1.0million letter of credit with LaSalle Bank N.A., with MTI’s landlord asbeneficiary.  The term of the lease isapproximately five years commencing on the date that the landlord substantiallycompletes improvements to the premises as set forth in the lease.  The lease also provides MTI an option toextend the term of the lease for an additional six years.  The basic rental amount for the leased spaceis initially $68 thousand per month and increases annually over the term of thelease up to a maximum of $93 thousand per month.

 

On October 13, 2005, weand MTI finalized the terms of the unsecured term note and MTI executedit.  Under the Note, MTI may make drawdowns from time to time in an aggregate amount not to exceed $2.3 million.  Each draw down under the note will bearinterest at a floating prime rate plus 2.3% and will be due and payable in 36consecutive monthly installments of principal, each in an amount equal to theamount of such draw down divided by 36, plus accrued interest, each due andpayable on the first business day of each calendar month commencing on thelater of November 1, 2005 or the first day of the month following the drawdown made under the note, and continuing on the first business day of eachsucceeding month thereafter for 36 consecutive months, at which time the unpaidamount of the draw down and all accrued and unpaid interest will be due andpayable in full.  MTI has the right toprepay the outstanding principal balance and accrued and unpaid interestthereon prior to maturity, without premium or penalty.  The note evidencing the loan containscustomary events of default, including, without limitation, payment defaultswith cure periods, bankruptcy and involuntary proceedings, monetary judgmentdefaults in excess of specified amounts, cross-defaults to other agreements andcertain changes of control.  For certainevents of default related to insolvency and receivership, the entireoutstanding unpaid principal balance of the note and all accrued and unpaidinterest thereon will automatically become immediately due and payable.  In the event of other defaults by MTI, we maydeclare the entire outstanding unpaid principal balance of the note and allaccrued and unpaid interest thereon to be immediately due and payable.  Upon an event of default, we may alsoexercise all rights and remedies under any other instrument, document, oragreement between MTI and us, enforce all rights and remedies under anyapplicable law, and offset any and all balances, credits, deposits, accounts,or monies of MTI then or thereafter with us, or any our obligations to MTIarising under any agreement or arrangement between us and MTI, against anyamounts due to us from MTI arising under the note.

 

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ev3Endovascular has provided MTI with a $1.0 million standby irrevocable letter ofcredit in favor of the Landlord to provide MTI with additional financing tosupport MTI’s planned improvements.  Theletter of credit expires on September 15, 2006, but will be automaticallyextended for successive one-year periods thereafter, unless LaSalle Bank N.A.notifies the parties that it does not intend to renew the letter of credit foran additional year at least 30 days prior to the expiration date, as suchexpiration date may be extended.

 

As of November 1, 2005,MTI has not drawn on the loan or letter of credit.

 

The acquisition agreementsrelating to our purchase of MitraLife, Appriva Medical, Inc. and DendronGmbH require us to make additional payments to the sellers of these businessesif certain milestones related to regulatory steps in the productcommercialization process are achieved. The potential milestone payments total$25.0 million, $175.0 million and $15.0 million with respect tothe MitraLife, Appriva and Dendron acquisitions, respectively, during theperiod of 2003 to 2009. We do not believe it is likely that we will haveobligations with respect to the MitraLife milestones in the future. We havedetermined that the first milestone with respect to the Appriva agreement wasnot achieved by the January 1, 2005 milestone date and that the firstmilestone is not payable.  On September 27,2005, we announced that we have decided to discontinue the development andcommercialization of our PLAATO device, which is the technology we acquired inthe Appriva transaction.  Although werecently had obtained conditional approval from the FDA for an investigationaldevice exemption, or IDE, clinical trial for the PLAATO device, we determinedthat, due to the time, cost and risk of enrollment, the trial design ultimatelymandated by the FDA was not commercially feasible for us at this time.  We continue to keep all of our options openwith regard to the future of the PLAATO technology, which may include a sale orlicensing of the technology to third parties. Under the terms of the stock purchase agreement we entered into inconnection with our acquisition of Dendron, we may be required to makeadditional payments which are contingent upon Dendron products achievingcertain revenue targets between 2003 and 2008. In 2003, the $4.0 millionrevenue target for sales of Dendron products during 2003 was met. Accordingly,an additional payment to the former Dendron stockholders of $3.75 millionwas made in 2004. In 2004, the $5.0 million revenue target for sales ofDendron products during 2004 was met. Accordingly, a payment to the former Dendronstockholders of $3.75 million was accrued in 2004 and was paid during thesecond quarter of 2005. We may be required to make a final payment of$7.5 million, which is contingent upon Dendron products achieving annualrevenues of $25 million in any year during the period between 2003 and2008. Any such final payment would be due in the year following the year oftarget achievement.

 

Our future liquidity andcapital requirements will be influenced by numerous factors, including clinicalresearch and product development programs, receipt of and time required toobtain regulatory clearances and approvals, sales and marketing programs andcontinuing acceptance of our products in the marketplace. We believe that theresources generated from our initial public offering are sufficient to meet ourliquidity requirements through the end of fiscal 2006; however, if we requireadditional working capital, but are not able to raise additional funds, we maybe required to significantly curtail or cease ongoing operations.

 

On May 6, 2005, MTIentered into an asset-based credit agreement with a bank that, subject tocustomary covenants, can provide up to $3.0 million of cash funding based onMTI’s U.S. accounts receivable and inventory balances. The loan iscollateralized by substantially all of MTI’s assets and expires in May 2007,as further described below.

 

MTI has received a supportletter from Warburg Pincus pursuant to which Warburg Pincus has agreed toprovide additional funding, up to $5.0 million, to MTI if needed to fundMTI’s operations. The Warburg Pincus commitment is effective through July 4,2006 and will be reduced to the extent of proceeds, if any, that becomeavailable from a third party lender, including amounts available under thecredit facility described above, or any amounts raised in a third partyfinancing.  We have negotiated anagreement with Warburg Pincus pursuant to which we have the first right tonegotiate an investment in MTI to further fund MTI’s operations, ifnecessary.  Pursuant to this agreement,we have agreed with MTI to provide the unsecured loan and letter of creditdescribed above.

 

In the event that we requireadditional working capital to fund future operations, we may negotiate afinancing arrangement with an independent institutional lender, sell notes topublic or private investors, sell additional shares of stock or other equitysecurities. There is no assurance that any financing transaction will beavailable on terms acceptable to us, or at all, or that any financing transactionwill not be dilutive to current stockholders. If we require additional workingcapital, but are not able to raise additional funds, we may be required tosignificantly curtail or

 

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cease ongoing operations. Fromtime to time, we may also sell a given technology or intellectual propertyhaving a development timeline or development cost that is inconsistent with ourinvestment horizon or which does not adequately complement our existing productportfolio.  Our future liquidity andcapital requirements will be influenced by numerous factors, including theextent and duration of future operating losses, the level and timing of futuresales and expenditures, market acceptance of new products, the results andscope of ongoing research and development projects, competing technologies,market and regulatory developments, and the future course of intellectualproperty litigation. See Note 5 and Note 16 to our consolidatedfinancial statements included in this report and Part II, Item 1, “LegalProceedings” in this report.

 

***MTI Financings and Liquidity***

 

As of October 2, 2005, weowned 70.2% of the outstanding shares of common stock of MTI and thereforeconsolidated MTI under generally accepted accounting principles. Although allof MTI’s assets are included in our consolidated balance sheets, not all ofthese assets would be available to us or our stockholders in the event of MTI’sliquidation. Because MTI has historically funded its operations independentlyfrom us, the following is a separate discussion of MTI’s financings andliquidity on a stand-alone basis. Historically, MTI has been funded throughequity private placements and the issuance of promissory notes. In threeseparate transactions since 2002, MTI has sold 27.5 million shares of itscommon stock and received approximately $68 million in net proceeds.

 

In addition to its operations,MTI has received cash payments from two private medical device companies inwhich it owned a minority equity interest. In January 2005, MTI received $3.7 million as a result of theconsummation of a sale of certain assets by Genyx Medical, Inc.  In May 2004, MTI received $1.7 millionof the amounts set aside in escrow in connection with Boston Scientific’smerger with Enteric Medical Technologies, Inc.  In May 2005, MTI received $878 thousandof the remaining portion of escrowed amounts under the merger agreement.  MTI expects to receive the remaining amountof approximately $850 thousand in May 2006, provided that no claims aremade by Boston Scientific against the amounts in escrow.

 

*Cash andcash equivalents.*    Asof October 2, 2005, MTI had cash and cash equivalents of $3.1 million.

 

*Operatingactivities.*  Cash used in MTI’s operations during the ninemonths ended October 2, 2005 was $9.2 million, reflecting primarily itsloss from operations, increases in trade receivables, inventories and prepaidexpenses, net of increases in accounts payable and accrued compensation, all ofwhich reflect the general increase in the volume of MTI’s operations, and adecrease in accrued liabilities that reflects primarily payments of, andreductions in, MTI’s estimates of amounts payable pursuant to the consolidationof MTI’s German facility into its Irvine, California operations in late 2004,and to reductions in MTI’s estimate of amounts payable pursuant to a previouslyterminated distributor agreement.  Weexpect that MTI’s operations will continue to consume cash during a substantialportion of the remainder of 2005, and achieve a breakeven cash flow fromoperations in early 2006.

 

*Investingactivities. *Cash provided by investing activities duringthe nine months ended October 2, 2005 was $145 thousand, primarilyresulting from the receipt of $3.7 million from the sale of assets of GenyxMedical, Inc, receipt of $878 thousand in connection with Boston Scientific’smerger with Enteric Medical Technologies, Inc., and the restoration tocash of certificates of deposit, aggregating $880 thousand, that had beensegregated from cash balances during the period that such certificates ofdeposit served as collateral for bank letters of credit which expired in 2005.Cash provided by investing activities during the nine months ended October 2,2005 was offset by a $3.75 million payment to the former Dendron stockholdersand the acquisition of property and equipment and capitalized patent costs.

 

Cash provided by financingactivities during the nine months ended October 2, 2005 was $294 thousand,consisting of proceeds from purchases of stock under MTI’s Employee StockPurchase Plan and from the exercise of stock options.

 

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*Otherliquidity information.*

 

On May 6, 2005, MTIentered into an asset-based credit agreement with a bank that, subject tocustomary covenants, provides up to $3.0 million of cash funding based on MTI’sU.S. accounts receivable and inventory balances. The loan is collateralized bysubstantially all of MTI’s assets and expires in May 2007. In addition,MTI has received a support letter from Warburg Pincus pursuant to which WarburgPincus has agreed to provide additional funding of up to $5.0 million toMTI, if needed, to fund MTI’s operations. The Warburg Pincus commitment iseffective through July 4, 2006 and will be reduced to the extent ofproceeds, if any, that become available from a third party lender, includingamounts available under the credit facility described above, or any amountsraised in a third party financing. We believe that MTI’s existing cash at October 2,2005, anticipated net cash flows related to operations for the remainder of2005 and for 2006, and the proceeds under either the credit facility or thefunding commitment of Warburg Pincus, will be sufficient to fund MTI’soperations for the next twelve months. There is no assurance that anyadditional financing transactions will be available on terms acceptable to MTIor us, or at all, or that any financing transactions will not be dilutive tocurrent MTI stockholders or our stockholders. There is no assurance that MTIwill achieve cash flow positive operations or that, if achieved, such cash flowpositive operations will be sustainable.

 

On October 13, 2005, MTIentered into a lease for approximately 96,400 square feet of new office,manufacturing and research facilities located in Irvine, California.  MTI expects to complete its relocation to thenew facility in April 2006.  Thelease for MTI’s current facility expired in September 2005, but is on amonth-to-month basis until such time as MTI has completed its relocation to thenew facility.  In connection with therelocation and accompanying tenant improvements, we agreed to provide MTI up to$2.3 million in an unsecured loan.  Theoutstanding principal amount under the loan will bear interest at a floatingprime rate plus 2.3%, will be payable in 36 consecutive monthly installments,plus accrued interest, after the date MTI has drawn down such amounts.  In addition to the our loan, ev3 Endovascular, Inc.has provided MTI with a $1.0 million standby irrevocable letter of credit infavor of the landlord for the new facilities, to provide the MTI withadditional financing to support the planned tenant improvements.

 

As of November 1, 2005,MTI has not drawn on the loan or letter of credit.

 

In connection with its acquisitionof Dendron, MTI may be required to make additional payments which arecontingent upon Dendron products achieving certain revenue targets between 2003and 2008, as described above under —Liquidity and Capital Resources—OtherLiquidity Information. In addition, German taxing authorities have not auditedthe income tax returns of Dendron since MTI’s acquisition of Dendron in October 2002.While we believe that Dendron has made its tax filings in conformity withGerman tax regulations, we are unable to predict what, if any, areas of inquirymight be pursued by German tax authorities in connection with an audit ingeneral, or specifically in connection with either MTI’s acquisition of Dendronor the subsequent closure of MTI’s German manufacturing facility or whether, orto what extent, Dendron will be subject to additional liability or tax.

 

**CriticalAccounting Policies and Estimates**

 

We have adopted variousaccounting policies to prepare our consolidated financial statements inaccordance with U.S. GAAP. Our most significant accounting policies aredescribed in Note 3 to our consolidated financial statements includedelsewhere in this report. The preparation of our consolidated financialstatements in conformity with U.S. GAAP requires us to make estimates andassumptions that affect the amounts reported in our consolidated financialstatements and accompanying notes. Our estimates and assumptions, includingthose related to bad debts, inventories, intangible assets, sales returns anddiscounts, and income taxes are updated as appropriate.

 

Certain of our more criticalaccounting policies require the application of significant judgment bymanagement in selecting the appropriate assumptions for calculating financialestimates. By their nature, these judgments are subject to an inherent degreeof uncertainty. These judgments are based on our historical experience, termsof existing contracts, our observance of trends in the industry, informationprovided by our physician customers, and information available from otheroutside sources, as appropriate. Different, reasonable estimates could havebeen used in the current period. Additionally, changes in accounting estimatesare reasonably likely to occur from period to period. Both of these factorscould have a material impact on the presentation of our financial condition,changes in financial condition or results of operations.

 

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We believe that the followingfinancial estimates are both important to the portrayal of our financialcondition and results of operations and require subjective or complexjudgments. Further, we believe that the items discussed below are properlyrecorded in our consolidated financial statements for all periods presented.Management has discussed the development, selection, and disclosure of our mostcritical financial estimates with the audit committee of our board of directorsand our independent auditors. The judgments about those financial estimates arebased on information available as of the date of our consolidated financialstatements. Those financial estimates include:

 

***Revenue Recognition***

 

We recognize revenue inaccordance with Securities and Exchange Commission Staff Accounting Bulletin No. 101,*Revenue Recognition in Financial Statements*,which requires that four basic criteria must be met before sales can berecognized: (1) persuasive evidence of an arrangement exists; (2) deliveryhas occurred or services have been rendered; (3) the price is fixed ordeterminable; and (4) collectibility is reasonably assured. These criteriaare met at the time of shipment when risk of loss and title passes to thecustomer or distributor, unless a consignment arrangement exists. Sales fromconsignment arrangements are recognized upon written acknowledgement that theproduct has been used by the customer indicating that a sale is complete. Ourterms of sale for regular sales are typically FOB shipping point, net30 days. Regular sales include orders from customers for replacement ofcustomer stock, replenishment of customer consignment product, orders for ascheduled case/surgery and stocking orders.

 

We allow customers to returndefective or damaged products for credit. Our estimate for sales returns isbased upon contractual commitments and historical return experience which weanalyze both by distribution channel and by geography and is recorded as areduction of sales. Historically our return experience has been low with returnrates approximating 3.0% of sales.

 

***Allowance for Doubtful Accounts***

 

We make judgments as to ourability to collect outstanding receivables and provide allowance for a portionof receivables when collection becomes doubtful. Provisions are made based upona specific review of all significant outstanding account balances and theoverall quality and age of those balances not specifically reviewed. Indetermining the provision for invoices not specifically reviewed, we analyzehistorical collection experience and current economic trends. If the historicaldata used to calculate the allowance provided for doubtful accounts does notreflect our future ability to collect outstanding receivables or if thefinancial condition of customers were to deteriorate, resulting in impairmentof their ability to make payments, an increase in the provision for doubtfulaccounts may be required. We maintain a large customer base that mitigates therisk of concentration with one customer. However, if the overall condition ofthe health care industry were to deteriorate, resulting in an impairment of ourcustomers’ ability to make payments, significant additional allowances could berequired.

 

Our accounts receivablebalance was $23.1 million and $19.0 million, net of accountsreceivable allowances, comprised of both allowances for doubtful accounts andsales returns of $3.3 million and $2.7 million, at October 2,2005 and December 31, 2004, respectively.

 

***Excess and Obsolete Inventory***

 

We calculate an inventoryreserve for estimated obsolescence or excess inventory based on historicalturnover and assumptions about future demand for our products and marketconditions. Our industry is characterized by regular new product development,and as such, our inventory is at risk of obsolescence following theintroduction and development of new or enhanced products. Our estimates andassumptions for excess and obsolete inventory are reviewed and updated on aquarterly basis. The estimates we use for demand are also used for near-termcapacity planning and inventory purchasing and are consistent with our sales forecasts.Future product introductions and related inventories may require additionalreserves based upon changes in market demand or introduction of competingtechnologies. Increases in the reserve for excess and obsolete inventory resultin a corresponding expense to cost of goods sold. Our reserve for excess andobsolete inventory was $3.8 million and $3.7 million at October 2,2005 and December 31, 2004, respectively.

 

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***Valuation of Acquired In-Process Researchand Development, Goodwill and Other Intangible Assets***

 

When we acquire anothercompany, the purchase price is allocated, as applicable, between acquiredin-process research and development (IPR&D), other identifiable intangibleassets, tangible net assets and goodwill as required by U.S. GAAP. In-processresearch and development is defined as the value assigned to those projects forwhich the related products have not received regulatory approval and have noalternative future use. Determining the portion of the purchase price allocatedto in-process research and development and other intangible assets requires usto make significant estimates that may change over time. During the nine monthsended October 2, 2005, we recorded an IPR&D charge of $868 thousandrelated to the May 26, 2005 contribution to ev3 LLC by Vertical of certainshares of MTI directly held by Vertical.

 

The income approach was usedto determine the fair values of the acquired IPR&D. This approachestablishes fair value by estimating the after-tax cash flows attributable tothe in-process project over its useful life and then discounting theseafter-tax cash flows back to the present value. Revenue estimates were based onrelative market size, expected market growth rates and market sharepenetration. Gross margin estimates were based on the estimated cost of theproduct at the time of introduction and historical gross margins for similarproducts offered by us or by competitors in the marketplace. The estimatedselling, general and administrative expenses were based on historical operatingexpenses of the acquired company as well as long-term expense levels based onindustry comparables. The costs to complete each project were based onestimated direct project expenses as well as the remaining labor hours andrelated overhead costs. In arriving at the value of acquired in-processresearch and development projects, we considered the project’s stage ofcompletion, the complexity of the work to be completed, the costs alreadyincurred, the remaining costs to complete the project, the contribution of coretechnologies, the expected introduction date and the estimated useful life ofthe technology. The discount rate used to arrive at the present value ofacquired in-process research and development as of the acquisition date wasbased on the time value of money and medical technology investment riskfactors. The discount rates used ranged from 15% to 34%. We believe that theestimated acquired in-process research and development amounts determinedrepresent the fair value at the date of acquisition and do not exceed theamount a third party would pay for the projects.

 

Goodwill represents the excessof the aggregate purchase price over the fair value of net assets, includingIPR&D, of the acquired businesses. Goodwill is tested for impairmentannually, or more frequently if changes in circumstance or the occurrence ofevents suggest an impairment exists. The test for impairment requires us tomake several estimates about fair value, most of which are based on projectedfuture cash flows. Our estimates associated with the goodwill impairment testsare considered critical due to the amount of goodwill recorded on ourconsolidated balance sheets and the judgment required in determining fair valueamounts, including projected future cash flows. Goodwill was $94.5 millionat October 2, 2005 and December 31, 2004.

 

Other intangible assetsconsist primarily of purchased developed technology, patents, customerrelationships and trademarks and are amortized over their estimated usefullives, ranging from 5 to 8 years. We review these intangible assets forimpairment annually during our fourth fiscal quarter or as changes incircumstance or the occurrence of events suggest the remaining value may not berecoverable. Other intangible assets, net of accumulated amortization, were$28.5 million and $31.9 million at October 2, 2005 and December 31,2004, respectively.

 

The evaluation of assetimpairments related to goodwill and other intangible assets require us to makeassumptions about future cash flows over the life of the assets beingevaluated. These assumptions require significant judgment and actual resultsmay differ from assumed or estimated amounts.

 

***Accounting for Income Taxes***

 

As part of the process ofpreparing our consolidated financial statements, we are required to determineour income taxes in each of the jurisdictions in which we operate. This processinvolves estimating our actual current tax expense together with assessingtemporary differences resulting from recognition of items for income tax andaccounting purposes. These differences result in deferred tax assets andliabilities, which are included on our consolidated balance sheets. We mustthen assess the likelihood that our deferred tax assets will be recovered fromfuture taxable income and, to the extent we believe that recovery is notlikely, we must establish a valuation

 

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allowance. To the extent weestablish a valuation allowance or increase this allowance in a period, we mustreflect this increase as an expense within the tax provision in ourconsolidated statement of operations.

 

Management’s judgment isrequired in determining our provision for income taxes, our deferred tax assetsand liabilities and any valuation allowance recorded against our net deferredtax assets. We will continue to monitor the realizability of our deferred taxassets and adjust the valuation allowance accordingly.

 

**Seasonality**

 

Our business is seasonal in nature.Historically, demand for our products has been the highest in our fourth fiscalquarter. We traditionally experience lower sales volumes in our third fiscalquarter than throughout the rest of the year as a result of the Europeanholiday schedule during the summer months.

 

**Off-BalanceSheet Arrangements**

 

We do not have any off-balancesheet arrangements, as defined by the rules and regulations of theSecurities and Exchange Commission, that have or are reasonably likely to havea material effect on our financial condition, changes in financial condition,revenues or expenses, results of operations, liquidity, capital expenditures orcapital resources.  As a result, we are not materially exposed to anyfinancing, liquidity, market or credit risk that could arise if we had engagedin these arrangements.

 

**RecentAccounting Pronouncements**

 

In November 2004, theFinancial Accounting Standards Board, or FASB, issued Statement of FinancialAccounting Standards, or SFAS, 151, *InventoryCosts, An Amendment of Accounting Research Bulletin No. 43, Chapter 4*,which adopts wording from the International Accounting Standards Board’s, orIASB, IAS 2 *Inventories* in aneffort to improve the comparability of cross-border financial reporting. Thenew standard indicates that abnormal freight, handling costs and wastedmaterials (spoilage) are required to be treated as current period chargesrather than as a portion of inventory cost. Additionally, the standardclarifies that fixed production overhead should be allocated based on thenormal capacity of a production facility. The statement is effective for usbeginning in 2006. Adoption is not expected to have a material impact on ourresults of operations, financial position or cash flows.

 

On December 16, 2004, theFASB issued SFAS 123(R), *Share-BasedPayment*, which is a revision of SFAS 123, *Accounting for Stock-Based Compensation,*and supersedes APB Opinion 25, *Accountingfor Stock Issued to Employees*. SFAS 123(R) requires allshare-based payments to employees, including grants of employee stock options,to be valued at fair value on the date of grant, and to be expensed over theapplicable vesting period and is effective for us on January 1, 2006. Wehave not yet determined the impact of the provisions of SFAS 123(R) on ourresults of operations, financial position or cash flows.

 

**Forward-LookingStatements**

 

This quarterly report on Form 10-Qcontains not only historical information, but also forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934 and are subject to the safe harborcreated by those sections.  In addition,we or others on our behalf may make forward-looking statements from time totime in oral presentations, including telephone conferences and/or web castsopen to the public, in press releases or reports, on our Internet web site orotherwise.  All statements other thanstatements of historical facts included in this report that address activities,events or developments that we expect, believe or anticipate will or may occurin the future are forward-looking statements including, in particular, thestatements about ev3’s plans (including MTI), objectives, strategies andprospects regarding, among other things, the financial condition, results ofoperations and business of ev3 Inc. and its subsidiaries.  We have identified some of theseforward-looking statements with words like “believe,” “may,” “could,” “might,” “forecast,”“possible,” “potential,” “project,” “will,” “should,” “expect,” “intend,” “plan,”“predict,” “anticipate,” “estimate,” “approximate” or “continue” and otherwords and terms of similar meaning. These forward-looking statements may

 

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be contained in the notes toour consolidated financial statements and elsewhere in this report, includingunder the caption “Management’s Discussion and Analysis of Financial Conditionand Results of Operations”.

 

We wish to caution readers notto place undue reliance on any forward-looking statement that speaks only as ofthe date made and to recognize that forward-looking statements are predictionsof future results, which may not occur as anticipated.  Actual results could differ materially fromthose anticipated in the forward-looking statements and from historicalresults, due to the risks and uncertainties described under the heading “RiskFactors” below, as well as others that we may consider immaterial or do notanticipate at this time. Although we believe that the expectations reflected inour forward-looking statements are reasonable, we do not know whether ourexpectations will prove correct.  Ourexpectations reflected in our forward-looking statements can be affected byinaccurate assumptions we might make or by known or unknown risks anduncertainties, including those described below under the heading “Risk Factors”.  The risks and uncertainties described underthe heading “Risk Factors” below are not exclusive and further informationconcerning us and our business, including factors that potentially couldmaterially affect our financial results or condition, may emerge from time totime.  We assume no obligation to updateforward-looking statements to reflect actual results or changes in factors orassumptions affecting such forward-looking statements.  We advise you, however, to consult anyfurther disclosures we make on related subjects in our annual reports on Form 10-K,quarterly reports on Form 10-Q and current reports on Form 8-K wefile with or furnish to the Securities and Exchange Commission.

 

**Risk Factors**

 

***Uncertainty related to our acquisition of all of the outstanding sharesof common stock of MTI that we do not already own through a merger, litigationrelating to such transaction or the failure to achieve the anticipatedefficiencies and cost savings as a result of this transaction could adverselyimpact our business and results of operations.***

 

On November 14, 2005, weannounced that we and Micro Investment, LLC, our wholly owned subsidiary,entered into an Agreement and Plan of Merger with MTI pursuant to which wewould acquire the shares of MTI that we do not already own.  Uncertainty about whether and when thistransition will be completed could adversely affect our business.  Failure to complete the proposed transactionfor any reason could subject us to several risks, including the following:

 

•                                          having incurred certain costs relating to thetransaction that are payable whether or not the transaction is completed,including legal, accounting and financial advisor fees;

 

•                                          having had the focus of our management directedin part toward the transaction instead of solely on our core business and otheropportunities that could have been beneficial to us; and

 

•                                          our inability to realize any of the expectedbenefits of having completed the transaction.

 

As a result, our failure tocomplete the transaction could negatively impact the price of our common stockand our future business and results of operations. We, MTI and each of MTI’sdirectors are parties to a lawsuit relating to this transaction, as describedin Part II, Item 1 of this report, which could expose us and MTI toliability or impede the completion of the transaction.  In addition, even if we do complete thetransaction, we may not be able to achieve the anticipated efficiencies andcost savings.

 

***Unless otherwise indicated, the following risk factors regarding ourbusiness do not take into account our acquisition of all of the outstandingshares of common stock of MTI that we do not already own***.

 

***We have a history of operating losses and negative cash flow.***

 

Our operations to date haveconsumed substantial amounts of cash, and we expect this condition tocontinue.  We had an accumulated deficitof $540.7 million at October 2, 2005. Our ability to achieve cash flow positive operations will be influencedby many factors, including the extent and duration of our future operatinglosses, the level and timing of future sales and expenditures, marketacceptance of new products, the results and scope of ongoing research anddevelopment projects, competing technologies, market and regulatorydevelopments and the future course of intellectual property litigation.  If adequate cash flow is not available to us,our business will be negatively impacted.

 

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***Some of our products are emerging technologies or have been recentlyintroduced into the market and may not achieve market acceptance once they areintroduced into their markets, which could adversely affect our business.***

 

Even if we are successful indeveloping safe and effective products that receive regulatory approval, ourproducts may not gain market acceptance. Our market share for our existing products may not grow, and our productsthat have yet to be introduced may not be accepted in the market.  We will need to invest in significanttraining and education of our physician customers to achieve market acceptanceof our products with no assurance of success. In order for any of our products to be accepted, we must address theneeds of potential customers and our customers must believe our products areeffective and commercially beneficial. However, even if customers accept our products, this acceptance may nottranslate into sales if our competitors have developed similar products thatour customers prefer.  If our products donot gain market acceptance or if our customers prefer our competitors’products, our business could be adversely affected.

 

***Delays in product introductions could adversely affect our net sales.***

 

The endovascular device marketis highly competitive and designs change often to adjust to patent constraintsand to changing market preferences. Therefore, product life cycles are relatively short.  As a result, any delays in our productlaunches may significantly impede our ability to enter or compete in a givenmarket and may reduce the sales that we are able to generate from theseproducts.  We may experience delays inany phase of a product launch, including during research and development, clinicaltrials, manufacturing, marketing and the education process.  In addition, our suppliers of products thatwe do not manufacture can suffer similar delays, which could cause delays inour product introductions.  If we sufferdelays in product introductions, our net sales could be adversely affected.

 

***If third parties claim that we infringe upon their intellectualproperty rights, we may incur liabilities and costs and may have to redesign ordiscontinue selling the affected product.***

 

The medical device industry islitigious with respect to patents and other intellectual property rights.Companies operating in our industry routinely seek patent protection for theirproduct designs, and many of our principal competitors have large patentportfolios.  Companies in the medicaldevice industry have used intellectual property litigation to gain acompetitive advantage.  Whether a productinfringes a patent involves complex legal and factual issues, the determinationof which is often uncertain.  We face therisk of claims that we have infringed on third parties’ intellectual propertyrights.  Prior to launching major newproducts in our key markets, we normally evaluate existing intellectualproperty rights. However, our competitors may also have filed for patentprotection which is not as yet a matter of public knowledge or claim trademarkrights that have not been revealed through our availability searches.  Our efforts to identify and avoid infringingon third parties’ intellectual property rights may not always besuccessful.  Any claims of patent orother intellectual property infringement, even those without merit, could:

 

•                                          be expensive and time consuming to defend;

 

•                                          result in us being required to pay significantdamages to third parties;

 

•                                          cause us to cease making or selling productsthat incorporate the challenged intellectual property;

 

•                                          require us to redesign, reengineer or rebrandour products, if feasible;

 

•                                          require us to enter into royalty or licensingagreements in order to obtain the right to use a third party’s intellectualproperty, which agreements may not be available on terms acceptable to us or atall;

 

•                                          divert the attention of our management; or

 

•                                          result in our customers or potential customersdeferring or limiting their purchase or use of the affected products untilresolution of the litigation.

 

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Inaddition, new patents obtained by our competitors could threaten a product’scontinued life in the market even after it has already been introduced.

 

***We are currently a party to a number ofintellectual property claims, the resolution of which could have a materialadverse effect on our business and results of operations.***

 

Wecannot assure you that we do not infringe any patents or other proprietaryrights held by third parties. In that regard, in March 2005, Medtronic, Inc.contacted us to express its view that our Protégé stents infringe on one ormore of its patents.  We informedMedtronic that we disagree with its assertions, and have since had severaldiscussions with Medtronic.  No lawsuitwith respect to this matter has been filed. We also received notice from anindividual regarding our Percutaneous Left Atrial Appendage TranscatheterOcclusion device, or PLAATO®, which is designed to reduce the risk of stroke byoccluding the left atrial appendage, a small pocket attached to the heart’sleft upper chamber that has limited functional use and is the location of amajority of blood clots in the heart. The individual claims that he believes our PLAATO device infringes ontwo of his patents.  We have informedthis individual that we do not believe that our PLAATO device infringes onthese patents.  We have also informedthis individual of our decision to discontinue the development and commercializationof the PLAATO device.  In March 2005,we were served with a complaint by Boston Scientific Corporation and one of itsaffiliates which claims that some of our products, including our SpideRXEmbolic Protection Device, infringe on certain of Boston Scientific’spatents.  Boston Scientific is seekingmonetary damages from us and to enjoin us from the alleged infringement.  We have answered the complaint, and we intendto vigorously defend this action. Because these matters are in early stages, wecannot estimate the possible loss or range of loss, if any, associated withtheir resolution.  However, there can beno assurance that the ultimate resolution of these matters will not result in amaterial adverse effect on our business, financial condition or results ofoperations.  If our products were foundto infringe on any proprietary rights of a third party, we could be required topay significant damages or license fees to the third party or cease production,marketing and distribution of those products, which could in turn have amaterial adverse effect on our business, financial condition and results ofoperations. Litigation may also be necessary to enforce patent rights we holdor to protect trade secrets or techniques we own.

 

Wemay also be subject to disputes as to the ownership of patents that we maydevelop with other companies.  Suchdisputes could result in the enjoining of sales of our products or our beingrequired to pay commercially unreasonable licensing fees.  If this occurs, our net sales or the cost ofselling the infringing product, and therefore our results of operations, wouldbe negatively affected.

 

MTIis involved in several patent disputes. Prior to MTI’s acquisition of Dendron GmbH, Dendron became involved inlitigation in Europe involving patents covering certain of its products, whichlitigation is still active.  Concurrentwith its acquisition of Dendron, MTI initiated a series of legal actions in theNetherlands and the United Kingdom with the primary purpose of asserting bothinvalidity and non-infringement by it of certain patents held by others withrespect to detachable coils and certain delivery systems.  In addition, the patent holders against whomMTI initiated the actions in the Netherlands and the United Kingdom haveinitiated legal actions against MTI in the United States that allegeinfringement by MTI of certain patents held by them.  An adverse determination in a judicial oradministrative proceeding or failure to obtain licenses, if necessary, couldprevent MTI from manufacturing and selling its products, which would in turnhave an adverse effect on our business and results of operations.  See Note 16 to the consolidatedfinancial statements included in this report and Part II, Item 1, “LegalProceedings” in this report.

 

 ***If there is a disruption in the supply of the products ofInvatec S.r.l. that we distribute or if our relationship with Invatec isimpaired, our net sales and results of operations would be adversely impacted.***

 

Wehave entered into an agreement with Invatec S.r.l., or Invatec, an Italianmanufacturer of endovascular medical devices which prior to our arrangementhave not been marketed or sold under the Invatec brand in the United States, todistribute Invatec’s branded products throughout the United States.  Although our contract with Invatec gives usthe exclusive right to market Invatec’s products using the Invatec brand in theUnited States, Invatec retained the right to sell its products into the UnitedStates under other brands, which it currently does.  In 2004, we increased our U.S. cardioperipheral sales force by adding 40 new sales representatives partially inreliance on this agreement and have invested significantly in regulatory,intellectual property and clinical activities to support the introduction ofInvatec’s products in the United States. Our success in marketing the Invatec products will depend on these new

 

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salespersonnel becoming proficient in the product line, building physicianrelationships and executing sales orders. If we are unable to market Invatec’s products successfully or if ouragreement with Invatec is terminated, our net sales and results of operationswould suffer.  If we do not meet ourperformance requirements under the agreement, the agreement may be terminatedby Invatec and we may be obligated to make substantial payments toInvatec.  In addition, even if we marketInvatec’s products successfully, if Invatec is unable to produce enough of itsproducts to meet our demands, including if Invatec sells its inventory to ourcompetitors rather than to us for marketing under their own brands, we may notbe able to meet our customers’ demands and our net sales and results ofoperations may suffer.  We also may notbe successful in managing the larger inventory and greater variety of productofferings that we will experience in connection with the Invatec relationshipand our net sales and results of operations may be adversely impacted.

 

***If our patents and other intellectualproperty rights do not adequately protect our products, we may lose marketshare to our competitors and be unable to operate our business profitably.***

 

Oursuccess depends significantly on our ability to protect our proprietary rightsto the technologies used in our products. We rely on patent protection, as well as a combination of copyright andtrademark laws and nondisclosure, confidentiality and other contractualarrangements to protect our proprietary technology.  However, these legal means afford onlylimited protection and may not adequately protect our rights or permit us togain or keep any competitive advantage. In addition, we cannot be assured that any of our pending patentapplications will result in the issuance of a patent to us.  The United States Patent and TrademarkOffice, or PTO, may deny or require significant narrowing of claims in ourpending patent applications, and patents issued as a result of the pendingpatent applications, if any, may not provide us with significant commercialprotection or be issued in a form that is advantageous to us.  We could also incur substantial costs inproceedings before the PTO.  Theseproceedings could result in adverse decisions as to the priority of ourinventions and the narrowing or invalidation of claims in issued patents.  Our issued patents and those that may beissued in the future may be challenged, invalidated or circumvented, whichcould limit our ability to stop competitors from marketing related products.Although we have taken steps to protect our intellectual property andproprietary technology, there is no assurance that third parties will not beable to design around our patents.  Wealso rely on unpatented proprietary technology. We cannot assure you that we can meaningfully protect all our rights inour unpatented proprietary technology or that others will not independentlydevelop substantially equivalent proprietary products or processes or otherwisegain access to our unpatented proprietary technology. We seek to protect ourknow-how and other unpatented proprietary technology, in part withconfidentiality agreements and intellectual property assignment agreements withour employees, independent distributors and consultants.  However, such agreements may not be enforceableor may not provide meaningful protection for our proprietary information in theevent of unauthorized use or disclosure or other breaches of the agreements orin the event that our competitors discover or independently develop similar oridentical designs or other proprietary information.  In addition, we rely on the use of registeredtrademarks with respect to the brand names of some of our products.  We also rely on common law trademarkprotection for some brand names, which are not protected to the same extent asour rights in the use of our registered trademarks.

 

Furthermore,the laws of foreign countries may not protect our intellectual property rightsto the same extent as the laws of the United States.  For example, foreign countries generally donot allow patents to cover methods for performing surgical procedures.  If we cannot adequately protect ourintellectual property rights in these foreign countries, our competitors may beable to compete more directly with us, which could adversely affect ourcompetitive position and our business.

 

Wealso hold licenses from third parties that are necessary to utilize certaintechnologies used in the design and manufacturing of some of our products.  The loss of such licenses would prevent usfrom manufacturing, marketing and selling these products, which could harm ourbusiness.

 

***We manufacture our products at singlelocations.  Any disruption in thesemanufacturing facilities or any patent infringement claims with respect to ourmanufacturing process could adversely affect our business and results ofoperations.***

 

Wehave relied to date principally on our manufacturing facility in Plymouth,Minnesota and our former facility in New Brighton, Minnesota, and MTI’sfacility in Irvine, California.  Weclosed our New Brighton, Minnesota manufacturing facility in July 2005 andmoved its operations to our Plymouth facility. In addition, in October 2005,

 

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MTIentered into a lease for new space in Irvine, California to which MTI willrelocate its existing Irvine operations, including its manufacturing facility.Our Plymouth and Irvine facilities and the manufacturing equipment we use toproduce our products would be difficult to replace and could require substantiallead-time to repair or replace.  Ourfacilities may be affected by natural or man-made disasters.  In the event one of our two facilities wasaffected by a disaster, we would be forced to rely on third-party manufacturersif we could not shift production to our other manufacturing facility.  In the case of a device with a pre-marketapproval application we may be required to obtain prior U.S. Food and DrugAdministration or notified body approval of an alternate manufacturingfacility, which could delay or prevent our marketing of the affected productuntil such approval is obtained. Although we believe we possess adequate insurance for damage to ourproperty and the disruption of our business from casualties, such insurance maynot be sufficient to cover all of our potential losses and may not continue tobe available to us on acceptable terms, or at all.  It is also possible that one of ourcompetitors could claim that our manufacturing process violates an existingpatent.  If we were unsuccessful in defendingsuch a claim, we may be forced to stop production at one or both of ourmanufacturing facilities in the United States and to seek alternativefacilities.  Even if we are able toidentify such alternative facilities, we may incur additional costs and we mayexperience a disruption in the supply of our products until those facilitiesare available.  Any disruption in ourmanufacturing capacity could have an adverse impact on our ability to producesufficient inventory of our products or may require us to incur additionalexpenses in order to produce sufficient inventory, and therefore may adverselyaffect our net sales and results of operations. Any disruption or delay at our manufacturing facilities could impair ourability to meet the demand of our customers and our customers may cancel ordersor purchase products from our competitors, which could adversely affect ourbusiness and results of operations.

 

***If we lose the services of our chiefexecutive officer or other key personnel, we may not be able to manage ouroperations and meet our strategic objectives.***

 

Ourfuture success depends, in large part, on the continued service of James M.Corbett, our president and chief executive officer.  Mr. Corbett’s continuation with us isintegral to our future success, based on his significant expertise andknowledge of our business and products. Although we have key person insurance with respect to Mr. Corbett,any loss or interruption of the services of Mr. Corbett couldsignificantly reduce our ability to effectively manage our operations andimplement our strategy.  Also, we dependon the continued service of key managerial, scientific, sales and technicalpersonnel, as well as our ability to continue to attract and retain additionalhighly qualified personnel, especially experienced medical device salespersonnel.  We compete for such personnelwith other companies, academic institutions, government entities and otherorganizations.  Any loss or interruptionof the services of our key personnel or any employee slowdowns, strikes orsimilar actions could significantly reduce our ability to effectively manageour operations and meet our strategic objectives because we cannot assure youthat we would be able to find appropriate replacements should the need arise.

 

***Our dependence on key suppliers puts us atrisk of interruptions in the availability of our products, which could reduceour net sales and adversely affect our results of operations. In addition,increases in prices for raw material and components used in our products couldadversely affect our results of operations.***

 

Werely on a limited number of suppliers for the raw materials and components usedin our products.  Our raw materials andcomponents are generally acquired through purchase orders placed in theordinary course of business, and we do not have any guaranteed or contractualsupply arrangements with many of our key or single source suppliers.  In addition, we also rely on independentcontract manufacturers for some of our products. Independent manufacturers havepossession of and in some cases hold title to molds for certain manufacturedcomponents of our products.  Ourdependence on third-party suppliers involves several risks, including limitedcontrol over pricing, availability, quality and delivery schedules, as well asmanufacturing yields and costs. Suppliers of raw materials and components may decide, or be required,for reasons beyond our control to cease supplying raw materials and componentsto us. Shortages of raw materials, quality control problems, productioncapacity constraints or delays by our contract manufacturers could negativelyaffect our ability to meet our production obligations and result in increasedprices for affected parts.  Any suchshortage, constraint or delay may result in delays in shipments of our productsor components, which could adversely affect our net sales and results ofoperations.

 

Inaddition, the FDA and foreign regulations may require additional testing of anyraw materials or components from new suppliers prior to our use of thesematerials or components.  In the case ofa device with a pre-market approval application, we may be required to obtainprior FDA approval of a new supplier, which could delay or

 

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preventour access or use of such raw materials or components or our marketing ofaffected products until such approval is granted.  In the case of a device with clearance under Section 510(k)of the Federal Food, Drug and Cosmetic Act, which we refer to as a 510(k), wemay be required to submit a new 510(k) if a change in a raw material orcomponent supplier results in a change in a material or component supplied thatis not within the 510(k) cleared device specifications.  If we need to establish additional orreplacement suppliers for some of these components, our access to thecomponents might be delayed while we qualify such suppliers and obtain anynecessary FDA approvals.  Our suppliersof finished goods are also subject to regulatory inspection and scrutiny.  Any adverse regulatory finding or actionagainst those suppliers could impact their ability to supply us goods fordistribution and sale.

 

***Existing or future acquisitions ofbusinesses could negatively affect our results of operations if we fail tointegrate the acquired businesses successfully into our existing operations orif we discover previously undisclosed liabilities.***

 

Inorder to build our core technology platform, we have acquired severalbusinesses since our inception and we may acquire additional businesses in thefuture.  Our ability to grow throughacquisitions depends upon our ability to identify, negotiate, complete andintegrate suitable acquisitions and to obtain any necessary financing.  Even if we complete acquisitions, we mayexperience:

 

•                                          difficulties in integrating any acquiredcompanies, personnel and products into our existing business;

 

•                                          delays in realizing projected efficiencies,cost savings, revenue synergies and other benefits of the acquired company orproducts;

 

•                                          inaccurate assessment of undisclosed,contingent or other liabilities or problems;

 

•                                          diversion of our management’s time andattention from other business concerns;

 

•                                          limited or no direct prior experience in newmarkets or countries we may enter;

 

•                                          higher costs of integration than weanticipated; or

 

•                                          difficulties in retaining key employees of theacquired business who are necessary to manage these acquisitions.

 

Inaddition, an acquisition could materially impair our operating results andliquidity by causing us to incur debt or reallocate amounts of capital fromother operating initiatives or requiring us to amortize acquisition expensesand acquired assets or incur non-recurring charges as a result of incorrectestimates made in the accounting for acquisitions.  We may also discover deficiencies in internalcontrols, data adequacy and integrity, product quality, regulatory complianceand product liabilities which we did not uncover prior to our acquisition ofsuch businesses, which could result in us becoming subject to penalties orother liabilities.  Any difficulties inthe integration of acquired businesses or unexpected penalties or liabilitiesin connection with such businesses could have a material adverse effect on ourresults of operations and financial condition. These risks could be heightenedif we complete several acquisitions within a relatively short period of time.

 

***We or MTI may require additional capital inthe future, which may not be available or may be available only on unfavorableterms.***

 

Ourand MTI’s capital requirements depend on many factors, including the amount ofexpenditures on intellectual property and technologies, the number of clinicaltrials which we conduct, new product development and new product acquisition.  To the extent that our or MTI’s existingcapital is insufficient to meet these requirements and cover any losses, wewill need to raise additional funds through financings or borrowings or curtailour growth and reduce our assets.  Fromtime to time, we may also sell a given technology or intellectual propertyhaving a development timeline or development cost that is inconsistent with ourinvestment horizon or which does not

 

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adequatelycomplement our existing product portfolio. We and MTI have each historically relied on financing from WarburgPincus and Vertical, but there can be no assurance that Warburg Pincus,Vertical or other investors will provide such financing in the future.  Any equity or debt financing, if available atall, may be on terms that are not favorable to us. Equity financings couldresult in dilution to our stockholders, and the securities issued in futurefinancings may have rights, preferences and privileges that are senior to thoseof our common stock.  If our need forcapital arises because of significant losses, the occurrence of these lossesmay make it more difficult for us to raise the necessary capital.  In addition, because MTI is not our whollyowned subsidiary, our creditors are limited in their ability to satisfy theirclaims against us by seeking recourse to MTI’s assets, which could impair ourability to obtain financing.

 

***We may experience conflicts of interestwith MTI with respect to business opportunities and other matters.***

 

Ourneurovascular operations are comprised of our interest in and relationshipswith MTI.  MTI is a public company whosestock is traded on the NASDAQ National Market System.  We own 70.2% of the outstanding shares ofcommon stock of MTI based on the number of shares outstanding as of October 2,2005. In addition, our board of directors is comprised of seven persons, fourof whom are also members of the board of directors of MTI.  These directors are James M. Corbett, RichardB. Emmitt, Dale A. Spencer and Elizabeth H. Weatherman.  Our relationships with MTI are significantelements of our business.  Under a numberof agreements that we have entered into with MTI, we:

 

•                                          are a distributor of certain of MTI’s products;

 

•                                          perform inventory and administrative serviceswith respect to finished goods inventory of certain of MTI’s neurovascularproducts;

 

•                                          provide MTI with marketing, sales solicitation,inventory management, accounting, invoicing, collection and administrativeservices in certain countries other than the United States and Canada; and

 

•                                          provide MTI distributor management services incertain countries other than the United States and Canada where MTI has anexisting third-party distributor for its products.

 

AlthoughMTI is our controlled subsidiary, it is not our wholly owned subsidiary, andconflicts of interest may arise with respect to transactions involving businessdealings between us and MTI, potential acquisitions of businesses or products,development of products and other matters with respect to which our bestinterests and the best interests of our stockholders may conflict with the bestinterests of the public stockholders of MTI. Because a portion of MTI is owned by minority stockholders, we cannottreat MTI as we would a wholly owned subsidiary.  With respect to our transactions with MTI,although we have formed a special committee of our board of directors thatconsists of all of the non-MTI directors to alleviate conflict of interestconcerns, we cannot assure you that we will negotiate terms that are asfavorable to us as if such transactions were with an unaffiliated third partyor that any conflicts of interest will be resolved in our favor.  Further, the fiduciary duties of the membersof MTI’s board of directors may result in actions that are not in ourstockholders’ best interests.  Because ofits importance to our business, we may elect to fund MTI’s operations incircumstances in which we undertake a large amount of risk but which willbenefit all of MTI’s stockholders, including its public stockholders, and fromwhich we may only receive the economic benefit in proportion to our ownershipinterest in MTI.  In addition, we arerequired to share any dividends that are declared by MTI on its common stock orother distributions of its assets with MTI’s public stockholders on a pro ratabasis, which will restrict our ability to access any funds and assets held byMTI.

 

***The value of our interest in MTI maydecline or our interest in MTI could be diluted.***

 

Anydecline in the market price of MTI’s common stock on the NASDAQ National MarketSystem will cause the value of the shares of MTI’s common stock which we own todecline.  MTI has not been profitablesince its founding and may continue to incur significant losses and negativecash flows in the future, which could negatively impact the market price of itscommon stock and the value of the MTI shares that we own.  For example, MTI may engage in equityfinancings or acquisitions of businesses or assets using equity that result inthe dilution of our interest in MTI. Although we have the right to provide financing to MTI before WarburgPincus or Vertical, if we

 

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declineto exercise this right, Warburg Pincus or Vertical may also elect to providefinancing directly to MTI in the future. In the event that MTI raisesadditional capital through equity offerings to Warburg Pincus, Vertical orother investors, our ownership interest in MTI could be diluted.

 

***Our sales would decline if our customers ortheir patients cannot obtain third party reimbursement for their purchases ofour products.***

 

Salesof our products depend in part on the reimbursement by governmental and privatehealth care payors to our physician customers or their patients for thepurchase and use of our products.  In theUnited States, health care providers that purchase our products generally relyon third-party payors, principally federal Medicare, state Medicaid and privatehealth insurance plans, to pay for all or a portion of the cost of endovascularprocedures.  Reimbursement systems ininternational markets vary significantly by country, and by region within somecountries, and reimbursement approvals must be obtained on a country-by-countrybasis and can take up to 18 months or longer.  Many international markets havegovernment-managed health care systems that govern reimbursement for newdevices and procedures.  In most markets,there are private insurance systems as well as government-managed systems.  Additionally, some foreign reimbursementsystems provide for limited payments in a given period and therefore result inextended payment periods.  Any delays inobtaining, or an inability to obtain, reimbursement approvals could have amaterial adverse effect on our business. In addition, if the reimbursement policies of domestic or foreigngovernmental or private health care payors were to change, our customers wouldlikely change their purchasing patterns and/or the frequency of their purchasesof the affected products. Additionally, payors continue to review theircoverage policies carefully for existing and new therapies and can, withoutnotice, deny coverage for treatments that include the use of our products.  Our business would be negatively impacted tothe extent any such changes reduce reimbursement for our products.

 

Inaddition, some health care providers in the United States have adopted or areconsidering a managed care system in which the providers contract to providecomprehensive health care for a fixed cost per person.  Health care providers may attempt to controlcosts by authorizing fewer elective surgical procedures or by requiring the useof the least expensive devices possible, which could adversely affect the demandfor our products or the price at which we can sell our products.

 

Wealso sell a number of our products to physician customers who may elect to usethese products in ways that are not within the scope of the approval orclearance given by the FDA, often referred to as “off-label” use.  In the event that governmental or privatehealth care payors limit reimbursement for products used off-label, sales ofour products and our business would be materially adversely affected.

 

***Our products and facilities are subject toextensive regulation with which compliance is costly and which exposes us topenalties for non-compliance.  We may notbe able to obtain required regulatory approvals for our products in acost-effective manner or at all, which could adversely affect our business andresults of operations.***

 

Theproduction and marketing of our products and our ongoing research anddevelopment, preclinical testing and clinical trial activities are subject toextensive regulation and review by numerous governmental authorities both inthe United States and abroad. U.S. and foreign regulations applicable tomedical devices are wide-ranging and govern, among other things, the testing,marketing and pre-market review of new medical devices, in addition toregulating manufacturing practices, reporting, advertising, exporting, labelingand record keeping procedures.  We arerequired to obtain FDA approval or clearance before we can market our productsin the United States and certain foreign countries.  The regulatory process requires significanttime, effort and expenditures to bring our products to market, and we cannotassure that any of our products will be approved for sale.  Any failure to obtain regulatory approvals orclearances could prevent us from successfully marketing our products, whichcould adversely affect our business and results of operations.  Our failure to comply with applicableregulatory requirements could result in governmental agencies:

 

•                                          imposing fines and penalties on us;

 

•                                          preventing us from manufacturing or selling ourproducts;

 

•                                          bringing civil or criminal charges against us;

 

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•                                          delaying the introduction of our new productsinto the market;

 

•                                          recalling or seizing our products; or

 

•                                          withdrawing or denying approvals or clearancesfor our products.

 

Ifany or all of the foregoing were to occur, we may not be able to meet thedemands of our customers and our customers may cancel orders or purchaseproducts from our competitors, which could adversely affect our business andresults of operations.

 

Evenif regulatory approval or clearance of a product is granted, the approval orclearance could limit the uses for which the product may be labeled andpromoted, which may limit the market for our products.  Further, for a marketed product, itsmanufacturer and manufacturing facilities are subject to periodic reviews andinspections by FDA and foreign regulatory authorities.  Subsequent discovery of problems with aproduct, manufacturer or facility may result in restrictions on the product,manufacturer or facility, including withdrawal of the product from the marketor other enforcement actions.  Inaddition, regulatory agencies may not agree with the extent or speed ofcorrective actions relating to product or manufacturing problems.

 

Weare currently conducting clinical studies of some of our products under aninvestigational device exemption. Clinical studies must be conducted in compliance with regulations of theFDA and those of regulatory agencies in other countries in which we conductclinical studies.  The data collectedfrom these clinical investigations will ultimately be used to support marketclearance for these products.  There isno assurance that regulatory bodies will accept the data from these clinicalstudies or that they will ultimately allow market clearance for these products.

 

Whenrequired, with respect to the products we market in the United States we haveobtained pre-market notification clearance under Section 510(k), but we donot believe certain modifications we have made to our products require us tosubmit new 510(k) notifications. However, if the FDA disagrees with us and requires us to submit a new510(k) notification for modifications to our existing products, we may besubject to enforcement actions by the FDA and be required to stop marketing theproducts while the FDA reviews the 510(k) notification.  If the FDA requires us to go through alengthier, more rigorous examination than we had expected, our product introductionsor modifications could be delayed or canceled, which could cause our sales todecline.  In addition, the FDA maydetermine that future products will require the more costly, lengthy anduncertain pre-market approval application process. Products that are approvedthrough a pre-market approval application generally need FDA approval beforethey can be modified.  If we fail tosubmit changes to products developed under investigational device exemptions orpre-market approval applications in a timely or adequate manner, we may becomesubject to regulatory actions.

 

Becausewe are subject to extensive regulation in the countries in which we operate, weare subject to the risk that regulations could change in a way that wouldexpose us to additional costs, penalties or liabilities.  For example, in the United States we sell anumber of our products to physicians who may elect to use these products inways that are not within the scope of the approval or clearance given by theFDA or for other than FDA-approved indications, often referred to as “off-label”use.  There are laws and regulationsprohibiting the promotion of products for such off-label use which restrict ourability to market our products and could affect our growth.  Although we have strict policies against theunlawful promotion of products for off-label use and we train our employees onthese policies, it is possible that one or more of our employees will notfollow the policies, or that regulations would change in a way that may hinderour ability to sell such products or make it more costly to do so, which couldexpose us to financial penalties as well as loss of approval to market and sellthe affected products.  If we want tomarket any of our products for use in ways for which they are not currentlyapproved, we may need to conduct clinical trials and obtain approval fromappropriate regulatory bodies, which could be time-consuming and costly.  In addition, off-label use may not be safe oreffective and may result in unfavorable outcomes to patients, resulting inpotential liability to us.  Penalties orliabilities stemming from off-label use could have a material adverse effect onour results of operations.  In addition,if physicians cease or lessen their use of products for other than FDA-approvedindications, sales of our products could decline, which could materiallyadversely affect our net sales and results of operations.

 

Ifadditional regulatory requirements are implemented in the foreign countries inwhich we sell our products, the cost of developing or selling our products mayincrease.  For example, in Japan, newregulations became effective

 

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onApril 1, 2005 which increase the regulatory and quality assurancerequirements for both our manufacturing facilities and our offices located inJapan in order to obtain and maintain regulatory approval to market ourproducts there.  We expect that these newregulations will result in higher costs and delays in securing approval tomarket our products in Japan. In addition, we depend on our distributorsoutside the United States in seeking regulatory approval to market our devicesin other countries and we are therefore dependent on persons outside of ourdirect control to secure such approvals. For example, we are highly dependent on distributors in emerging marketssuch as China and Brazil for regulatory submissions and approvals and do nothave direct access to health care agencies in those markets to ensure timelyregulatory approvals or prompt resolution of regulatory or compliancematters.  If our distributors fail toobtain the required approvals or do not do so in a timely manner, our net salesfrom our international operations and our results of operations may beadversely affected.

 

Inaddition, our business, properties and products are subject to foreign,federal, state and local laws and regulations relating to the protection of theenvironment, natural resources and worker health and safety and the use,management, storage, and disposal of hazardous substances, wastes, and otherregulated materials. Because we own and operate real property, variousenvironmental laws also may impose liability on us for the costs of cleaning upand responding to hazardous substances that may have been released on ourproperty, including releases unknown to us. These environmental laws and regulations also could require us to payfor environmental remediation and response costs at third-party locations wherewe disposed of or recycled hazardous substances.  The costs of complying with these variousenvironmental requirements, as they now exist or may be altered in the future,could adversely affect our financial condition and results of operations.

 

***A number of our products are in clinicaltrials.  If these trials areunsuccessful, or if the FDA or other regulatory agencies do not accept theresults of such trials, these products may not successfully come to market andour business prospects may suffer.***

 

Severalof our products are in the early stages of development.  Some of our products only recently emergedfrom clinical trials and others have not yet reached the clinical trialstage.  Our currently ongoing clinicaltrials include the CREATE trial designed to evaluate the use of our SpideRXEmbolic Protection Devices and our Protégé Self-Expanding Stent System incarotid artery stenting procedures in patients who are high risk candidates forcarotid endarterectomy.  We cannot assureyou that we will be successful in reaching the endpoints in these trials or, ifwe do, that the FDA or other regulatory agencies will accept the results andapprove the devices for sale.  Further,we continually evaluate the potential financial benefits and costs of ourclinical trials and the products being evaluated in them.  If we determine that the costs associatedwith attaining regulatory approval of a product exceed the potential financialbenefits of that product or if the projected development timeline isinconsistent with our investment horizon, we may choose to stop a clinicaltrial and/or the development of a product. For example, in September 2005, we decided to discontinue thedevelopment and commercialization of our PLAATO device, which is designed toreduce the risk of stroke by occluding the left atrial appendage in theheart.  Although we recently had obtainedconditional approval from the FDA for an investigational device exemption, orIDE, clinical trial for our PLAATO device, we determined that, due to the time,cost and risk of enrollment, the trial design ultimately mandated by the FDAwas not commercially feasible for us at this time.

 

Ourability to market our products in the United States will depend upon a numberof factors, including our ability to demonstrate the safety and efficacy of ourproducts with valid clinical data.  Ourability to market our products outside of the United States is also subject toregulatory approval, including our ability to demonstrate the safety of ourproducts in the clinical setting.  Ourproducts may not be found to be safe and, where required, effective in clinicaltrials and may not ultimately be approved for marketing by U.S. or foreignregulatory authorities.  Our failure todevelop safe and effective products that are approved for sale on a timelybasis would have a negative impact on our net sales.  In particular, if we do not reach theendpoints or obtain FDA approval with respect to our products, our futuregrowth may be significantly hampered. In addition, some of the products forwhich we are currently conducting trials are already approved for sale outsideof the United States.  As a result, whileour trials are ongoing, unfavorable data may arise in connection with usage ofour products outside the United States which could adversely impact theapproval of such products in the United States. Conversely, unfavorable data from clinical trials in the United Statesmay adversely impact sales of our products outside of the United States.

 

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*** ***

***The risks inherent in operatinginternationally and the risks of selling and shipping our products and ofpurchasing our components and products internationally may adversely impact ournet sales, results of operations and financial condition.***

 

Wederive a significant portion of our net sales from operations in internationalmarkets.  For the nine months ended October 2,2005 and October 3, 2004, 47.0% and 49.2% of our net sales, respectively,were derived from our international operations. Our international distribution system consists of eight direct salesoffices and approximately 50 stocking distribution partners. In addition, wepurchase some components and products on the international market.  The sale and shipping of our products andservices across international borders, as well as the purchase of componentsand products from international sources, subject us to extensive U.S. andforeign governmental trade regulations. Compliance with such regulations iscostly and exposes us to penalties for non-compliance.  We recently reviewed our trade controlpractices as part of our ongoing commitment to further enhance our compliancepolicies and procedures.  As part of thisreview, we identified instances in which we may have incorrectly reportedinformation about certain shipments imported into the United States andEurope.  We have disclosed thesepotential reporting errors to customs regulators in the countries ofimportation in the United States and Europe, and while we believe that nomonies are owed to any government as a result of these potential reportingerrors other than processing fees of a nonmaterial amount, we may incurpenalties, additional fees, interest and duty payments if the customsregulators disagree with our assessment. Any failure to comply with applicable legal and regulatory obligationscould impact us in a variety of ways that include, but are not limited to,significant criminal, civil and administrative penalties, includingimprisonment of individuals, fines and penalties, denial of export privileges,seizure of shipments, restrictions on certain business activities, andexclusion or debarment from government contracting.  Also, the failure to comply with applicablelegal and regulatory obligations could result in the disruption of our shippingand sales activities.

 

Inaddition, most of the countries in which we sell our products are, to somedegree, subject to political, economic and/or social instability.  Our international sales operations expose usand our representatives, agents and distributors to risks inherent in operatingin foreign jurisdictions.  These risksinclude:

 

•                                          the imposition of additional U.S. and foreigngovernmental controls or regulations;

 

•                                          the imposition of costly and lengthy new exportlicensing requirements;

 

•                                          the imposition of U.S. and/or internationalsanctions against a country, company, person or entity with whom the companydoes business that would restrict or prohibit continued business with thesanctioned country, company, person or entity;

 

•                                          economic instability;

 

•                                          a shortage of high-quality sales people anddistributors;

 

•                                          loss of any key personnel that possessproprietary knowledge, or who are otherwise important to our success in certaininternational markets;

 

•                                          changes in third-party reimbursement policiesthat may require some of the patients who receive our products to directlyabsorb medical costs or that may necessitate the reduction of the sellingprices of our products;

 

•                                          changes in duties and tariffs, licenseobligations and other non-tariff barriers to trade;

 

•                                          the imposition of new trade restrictions;

 

•                                          the imposition of restrictions on theactivities of foreign agents, representatives and distributors;

 

•                                          scrutiny of foreign tax authorities which couldresult in significant fines, penalties and additional taxes being imposed onus;

 

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•                                          pricing pressure that we may experienceinternationally;

 

•                                          laws and business practices favoring localcompanies;

 

•                                          longer payment cycles;

 

•                                          difficulties in enforcing agreements andcollecting receivables through certain foreign legal systems;

 

•                                          difficulties in enforcing or defendingintellectual property rights; and

 

•                                          exposure to different legal and politicalstandards due to our conducting business in over 50 countries.

 

Wecannot assure you that one or more of the factors will not harm ourbusiness.  Any material decrease in ourinternational sales would adversely impact our net sales, results of operationsand financial condition.  Our internationalsales are predominately in Europe.  InEurope, health care regulation and reimbursement for medical devices varysignificantly from country to country. This changing environment could adversely affect our ability to sell ourproducts in some European countries.

 

***Fluctuations in foreign currency exchangerates could result in declines in our reported net sales and earnings.***

 

Becausethe majority of our international sales are denominated in local currencies andnot in U.S. dollars, our reported net sales and earnings are subject tofluctuations in foreign exchange rates. Our international net sales were favorably affected by the impact offoreign currency fluctuations totaling $914 thousand in the nine months ended October 2,2005 and $1.9 million in the nine months ended October 3, 2004.  However, we cannot assure you that we willbenefit from the impact of foreign currency fluctuations in the future andforeign currency fluctuations in the future may adversely affect our net salesand earnings.  At present, we do notengage in hedging transactions to protect against uncertainly in futureexchange rates between particular foreign currencies and the U.S. dollar.

 

***We may become obligated to make largemilestone payments that are not currently reflected in our financial statementsin certain circumstances, which would negatively impact our cash flows fromoperations.***

 

Pursuantto the acquisition agreements relating to our purchase of MitraLife and ApprivaMedical, Inc. in January 2002 and August 2002, respectively, weagreed to make certain additional payments to the sellers of these businessesin the event that we achieve contractually defined milestones.  Generally, in each case, these milestonepayments become due upon the completion of specific regulatory steps in theproduct commercialization process.  Withrespect to the MitraLife acquisition, the maximum potential milestone paymentstotaled $25 million, and with respect to the Appriva acquisition, themaximum potential milestone payments totaled $175 million.

 

OnSeptember 29, 2004, we sold substantially all of the assets constitutingthe MitraLife business to Edwards Lifesciences and we are no longer pursuingcommercialization of the product line acquired in the MitraLifetransaction.  As of the date that we soldthese assets to Edwards Lifesciences, none of the milestones set forth in ouragreement with the sellers of MitraLife had been met.  We have determined that we have no currentobligations in respect of these milestone payments, and we do not believe thatit is likely that we will have obligations with respect to these milestones inthe future.  Although we do not believeit is likely that these milestone payment obligations will become due in the future,it is possible that the former stockholders of MitraLife could disagree andmake a claim for such payments.  Any suchdispute could be costly, result in payments in such amounts being made anddivert our management’s time and attention away from our business.

 

TheAppriva acquisition agreement contains four milestones to which paymentsrelate.  The first milestone was required by its terms to be achieved by January 1,2005 in order to trigger a payment equal to $50 million.  We havedetermined that the first milestone was not achieved by January 1, 2005and that the first milestone is not payable.

 

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OnMay 20, 2005, Michael Lesh,  as an individual seller of Apprivastock and purporting to represent certain othersellers of Appriva stock, filed a complaint in the Superior Court ofthe State of Delaware with individually specified damages aggregating$70 million and other unspecified damages for several allegations,including that we, along with other defendants,  breached the acquisitionagreement and an implied covenant of good faith and fair dealing by willfullyfailing to take the steps necessary to meet the first milestone under theagreement, and thereby also failing to meet certain other milestones, andfurther that one milestone was actually met.   The complaint alsoalleges fraud, negligent misrepresentation and violation of state securitieslaws in connection with the negotiation of the acquisition agreement.  Webelieve these allegations are without merit and intend to vigorously defendthis action.  On August 5, 2005, our attorneys received a letter fromattorneys representing certain other sellers of Appriva stock (who are notpurported to be represented in the action filed by Lesh), asking our attorneysto enter into a dialogue regarding their assertions that certain milestonepayments should have been made. We believe their assertions are without merit.On September 27, 2005, we announced our decision to discontinue thedevelopment and commercialization of our PLAATO device, which is the technologywe acquired in the Appriva transaction. While we do not believe that it is likely that we will have obligationswith respect to the first or other milestones, as discussed above, it ispossible that the former sellers of Appriva stock could disagree and make aclaim for such payments.  The defense andresolution of the currently outstanding litigation filed by Lesh regarding thefirst milestone payment, the failure to reach agreement with the new claimantson a resolution of our differences, or any similar dispute or other futurelitigation regarding the Appriva transaction milestone payments could be costlyand negatively impact our cash flow from operations, as well as divert ourmanagement’s time and attention away from our business.

 

***We rely on our independent salesdistributors and sales associates to market and sell our products outside ofthe United States, Canada, Europe and Japan.***

 

Salesof our products in locations outside of the United States, Canada, Europe andJapan represented 12% and 15% of our net sales in the nine months ended October 2,2005 and October 3, 2004, respectively. Our success outside of the United States, Canada, Europe and Japandepends largely upon marketing arrangements with independent sales distributorsand sales associates, in particular their sales and service expertise andrelationships with the customers in the marketplace.  Independent distributors and sales associatesmay terminate their relationship with us, or devote insufficient sales effortsto our products.  We do not control ourindependent distributors and they may not be successful in implementing ourmarketing plans. In addition, many of our independent distributors outside ofthe United States, Canada, Europe and Japan initially obtain and maintainforeign regulatory approval for sale of our products in their respectivecountries.  Our failure to maintain ourexisting relationships with our independent distributors and sales associatesoutside of the United States, Canada, Europe and Japan, or our failure torecruit and retain additional skilled independent sales distributors and salesassociates in these locations, could have an adverse effect on ouroperations.  We have experienced turnoverwith some of our independent distributors in the past that has adverselyaffected our short-term financial results while we transitioned to newindependent distributors.  Similaroccurrences could happen in the future.

 

***If physicians do not recommend and endorseour products, our sales may decline or we may be unable to increase our salesand profits.***

 

Inorder for us to sell our products, physicians must recommend and endorsethem.  We may not obtain the necessaryrecommendations or endorsements from physicians.  Acceptance of our products depends oneducating the medical community as to the distinctive characteristics,perceived benefits, safety, clinical efficacy and cost-effectiveness of ourproducts compared to products of our competitors, and on training physicians inthe proper application of our products. If we are not successful in obtaining the recommendations orendorsements of physicians for our products, our sales may decline or we may beunable to increase our sales and profits.

 

***If we fail to comply with the U.S. FederalAnti-Kickback Statute and similar state laws, we could be subject to criminaland civil penalties and exclusion from the Medicare and Medicaid programs,which could have a material adverse effect on our business and results ofoperations.***

 

Aprovision of the Social Security Act, commonly referred to as the FederalAnti-Kickback Statute, prohibits the offer, payment, solicitation or receipt ofany form of remuneration in return for referring, ordering, leasing, purchasingor arranging for or recommending the ordering, purchasing or leasing of itemsor services payable by

 

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Medicare,Medicaid or any other Federal health care program.  The Federal Anti-Kickback Statute is verybroad in scope and many of its provisions have not been uniformly ordefinitively interpreted by existing case law or regulations.  In addition, most of the states in which ourproducts are sold have adopted laws similar to the Federal Anti-KickbackStatute, and some of these laws are even broader than the Federal Anti-KickbackStatute in that their prohibitions are not limited to items or services paidfor by a Federal health care program but, instead, apply regardless of thesource of payment.  Violations of theFederal Anti-Kickback Statute may result in substantial civil or criminalpenalties and exclusion from participation in Federal health care programs.

 

Allof our financial relationships with health care providers and others whoprovide products or services to Federal health care program beneficiaries are potentiallygoverned by the Federal Anti-Kickback Statute and similar state laws.  We believe our operations are in materialcompliance with the Federal Anti-Kickback Statute and similar state laws.  However, we cannot assure you that we willnot be subject to investigations or litigation alleging violations of theselaws, which could be time-consuming and costly to us and could divertmanagement’s attention from operating our business, which could have a materialadverse effect on our business.  Inaddition, if our arrangements were found to violate the Federal Anti-KickbackStatute or similar state laws, it could have a material adverse effect on ourbusiness and results of operations.

 

***Our business strategy relies on assumptionsabout the market for our products, which, if incorrect, would adversely affectour business prospects and profitability.***

 

Weare focused on the market for endovascular devices used to treat vasculardiseases and disorders.  We believe thatthe aging of the general population and increasingly inactive lifestyles willcontinue and that these trends will increase the need for our products.However, the projected demand for our products could materially differ fromactual demand if our assumptions regarding these trends and acceptance of ourproducts by the medical community prove to be incorrect or do not materializeor if drug therapies gain more widespread acceptance as a viable alternativetreatment, which in each case would adversely affect our business prospects andprofitability.

 

***If MTI experiences a delay in the proposedrelocation of its existing manufacturing facility, the production of ourneurovascular products may be delayed.***

 

OnOctober 13, 2005, MTI entered into a lease for approximately 96,400 squarefeet of new office, manufacturing and research facilities located in Irvine,California.  MTI expects to occupy the new facilities and vacate itsexisting facilities in Irvine in April 2006.  MTI’s new facilities,which include expanded manufacturing capacity compared to its currentfacilities, will need to be qualified by regulatory agencies, including theFDA, prior to MTI being able to manufacture products.  If MTI is not ableto complete its relocation or regulatory qualification of its new facility in atimely manner, the production of our neurovascular products may be delayed andour net sales and business could be materially adversely affected.

 

***Our business, net sales and results ofoperations may suffer if we do not pass the required regulatory inspections forour new locations for manufacturing peripheral stents and our neurovascularproducts.***

 

Weclosed our New Brighton, Minnesota manufacturing facility in July 2005 andare currently in the process of integrating our manufacturing operationsformerly located in New Brighton, Minnesota, where we manufactured ourperipheral stent product line, with our manufacturing operations in Plymouth,Minnesota.  In addition, MTI intends torelocate its existing Irvine, California operations, including itsmanufacturing facility for our neurovascular products, to the new space it hasleased in Irvine.  We will be required topass regulatory inspections of the FDA**,**and possibly other regulatory agencies of countries in which we sell ourproducts, in connection with the new manufacturing operations in Plymouth andIrvine.  If we do not pass theseinspections or do not pass them on our expected schedule, we may not havesufficient inventory of various products, which may result in a backlog oforders, customer dissatisfaction and a reduction in sales. Consequently, ourbusiness, net sales and results of operations may suffer.  In addition, we are required to submit apre-market approval supplement application to the FDA for approval of thechange in manufacturing facilities for any devices marketed under a pre-marketapproval application. If we do not obtain timely approval of any requiredsupplement application, our business, net sales and results of operations mayalso be negatively impacted.

 

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***One of our families of products generates alarge portion of our net sales. Our net sales and business prospects would beadversely affected if sales of this product were to decline.***

 

Weare dependent on our Protégé GPS family of stents, which generated more than10% of our net sales in fiscal 2004 and more than 15% of our net sales in thenine months ended October 2, 2005. If our Protégé GPS stents were to no longer be available for sale in anykey market because of regulatory, intellectual property or any other reason,our net sales from these products and from products that typically constituteancillary purchases would significantly decline.  A significant decline in our net sales couldalso negatively impact our product development activities and therefore ourbusiness prospects.

 

InMarch 2005, Medtronic, Inc. contacted us to express its view that ourProtégé stents infringe on one or more of its patents, as described above.  We informed Medtronic that we disagree withits assertions, and have since had several discussions with Medtronic.  No lawsuit with respect to this matter hasbeen filed.

 

***We are exposed to product liability claimsthat could have an adverse effect on our business and results of operations.***

 

Themanufacture and sale of medical devices exposes us to significant risk ofproduct liability claims, some of which may have a negative impact on ourbusiness.  Our existing products weredeveloped relatively recently and defects or risks that we have not yetidentified may give rise to product liability claims. In addition, we haverecently initiated a new quality control system and a new manufacturing modelwhich has not been in effect long enough for us to have the confidence that anyerrors or mistakes in implementation have been corrected.  Our existing product liability insurancecoverage may be inadequate to protect us from any liabilities we may incur orwe may not be able to maintain adequate product liability insurance atacceptable rates.  If a product liabilityclaim or series of claims is brought against us for uninsured liabilities or inexcess of our insurance coverage and it is ultimately determined that we areliable, our business could suffer. Additionally, we could experience a material design or manufacturingfailure in our products, a quality system failure, other safety issues orheightened regulatory scrutiny that would warrant a recall of some of ourproducts.  A recall of some of ourproducts could also result in increased product liability claims.  Further, while we train our physiciancustomers on the proper usage of our products, we cannot ensure that they willimplement our instructions accurately. If our products are used incorrectly by our customers, injury may resultand this could give rise to product liability claims against us.  Any losses that we may suffer from anyliability claims, and the effect that any product liability litigation may haveupon the reputation and marketability of our products, may divert management’sattention from other matters and may have a negative impact on our business andour results of operations.

 

***Our net sales could decline significantlyif drug-eluting stents become a dominant therapy in the peripheral vascularstent market and we are not able to develop or acquire a drug-eluting stent tomarket and sell.***

 

Theperipheral vascular market is currently comprised exclusively of bare metal, ornon drug-eluting, stents.  However, thereare clinical situations in the periphery in which a drug-eluting stent maydemonstrate clinical superiority over bare metal stents.  To the extent that our peripheral stentcustomers seek stents with drug coatings and we do not market and sell adrug-eluting peripheral stent or one that achieves market acceptance, we maynot be able to compete as effectively with those of our competitors that areable to develop and sell a drug-eluting stent, and our peripheral stent salescould decline.  If our peripheral stentsales were to decline, we could experience a significant decline in sales ofsome of our other products which are routinely purchased in conjunction withstent purchases.

 

***If we are unable to continue to develop andmarket new products and technologies, we may experience a decrease in demandfor our products or our products could become obsolete, and our business wouldsuffer.***

 

Weare continually engaged in product development and improvement programs, andnew products represent a significant component of our growth rate.  We may not be able to compete effectivelywith our competitors unless we can keep up with existing or new products andtechnologies in the endovascular device market. If we do not continue tointroduce new products and technologies, or if those products and technologiesare not accepted, we may not be successful and our business would suffer.  Moreover, many of our clinical trials havedurations of several years and it is possible that competing therapies, such asdrug therapies, may be introduced while our products are

 

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stillundergoing clinical trials.  This couldreduce the potential demand for our products and negatively impact our businessprospects. Additionally, our competitors’ new products and technologies maybeat our products to market, may be more effective or less expensive than ourproducts or render our products obsolete.

 

***The marketing of our products requires asignificant amount of time and expense and we may not have the resources tosuccessfully market our products, which would adversely affect our business andresults of operations.***

 

Themarketing of our products requires a significant amount of time and expense inorder to identify the physicians who may use our products, invest in trainingand education, and employ a sales force that is large enough to interact withthe targeted physicians.  In addition,the marketing of our products requires interaction with many subspecialists whoare moving into new practice areas and may require more training and educationfrom our personnel than would be required with physicians who are not expandingtheir practice areas.  We may not haveadequate resources to market our products successfully against largercompetitors which have more resources than we do. If we cannot market our productssuccessfully, our business and results of operations would be adverselyaffected.

 

***We face competition from other companies,many of which have substantially greater resources than we do and may be ableto develop more effective products or offer their products at lower prices thanwe can, which could adversely impact our business, net sales and results ofoperations.  Consolidation in the medicaltechnology industry would exacerbate these risks.***

 

Themarkets in which we compete are highly competitive, subject to change andsignificantly affected by new product introductions and other activities ofindustry participants.  The markets forour products are also dominated by a small number of large companies, and weare a much smaller company relative to our primary competitors.  Our products compete with other medicaldevices, including Invatec manufactured products sold in the United Statesunder other brand names, surgical procedures and pharmaceutical products.  A number of the companies in the medicaltechnology industry, including manufacturers of peripheral vascular,cardiovascular and neurovascular products, have substantially greater capitalresources, larger customer bases, broader product lines, larger sales forces,greater marketing and management resources, larger research and developmentstaffs and larger facilities than ours and have established reputations withour target customers, as well as worldwide distribution channels that are moreeffective than ours. In addition, the industry has recently experienced someconsolidation.  Consolidation could makethe competitive environment more difficult for smaller companies.  Because of the size of the vascular diseasemarket opportunity, competitors and potential competitors have historicallydedicated and will continue to dedicate significant resources to aggressivelypromote their products. New product developments that could compete with usmore effectively are likely because the vascular disease market ischaracterized by extensive research efforts and technological progress.  Competitors may develop technologies andproducts that are safer, more effective, easier to use, less expensive or morereadily accepted than ours.  Theirproducts could make our technology and products obsolete or noncompetitive.  Our competitors may also be able to achievemore efficient manufacturing and distribution operations than we can and mayoffer lower prices than we could offer profitably.  We expect that as our products mature, wewill be able to produce our products in a more cost effective manner andtherefore be able to compete more effectively, but it is possible that we maynot achieve such cost reductions.  Any ofthese competitive factors could adversely impact our business, net sales andresults of operations.

 

Wealso compete with other manufacturers of medical devices for clinical sites toconduct human trials.  If we are not ableto locate clinical sites on a timely or cost-effective basis, this could impedeour ability to conduct trials of our products and, therefore, our ability toobtain required regulatory clearance or approval.

 

***We rely on our management informationsystems for inventory management, distribution and other functions and tomaintain our research and development and clinical data.  If our information systems fail to adequatelyperform these functions or if we experience an interruption in their operation,our business and results of operations could be adversely affected.***

 

Theefficient operation of our business is dependent on our management informationsystems.  We rely on our managementinformation systems to effectively manage accounting and financial functions;manage order entry, order fulfillment and inventory replenishment processes;and to maintain our research and development and clinical

 

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data.  The failure of our management informationsystems to perform as we anticipate could disrupt our business and productdevelopment and could result in decreased sales, increased overhead costs,excess inventory and product shortages, causing our business and results ofoperations to suffer.  In addition, ourmanagement information systems are vulnerable to damage or interruption from:

 

•                                          earthquake, fire, flood and other naturaldisasters;

 

•                                          terrorist attacks and attacks by computerviruses or hackers; and

 

•                                          power loss or computer systems, Internet,telecommunications or data network failure.

 

Anysuch interruption could adversely affect our business and results ofoperations.

 

***If MTI fails to timely report its financialresults or produce its financial statements, we may not be able to timelyreport our financial results or comply with Securities and Exchange Commissionreporting and certification requirements, and our stock price may decline.***

 

Asthe owner of a controlling interest in MTI, we consolidate the financialresults of MTI in our consolidated financial statements.  MTI accounted for a material portion of ournet sales and gross profit in each of the nine months ended October 2,2005 and October 3, 2004.  As aresult, our ability to report our financial results, produce our consolidatedfinancial statements and file required reports with the Securities and ExchangeCommission, or the SEC, in a timely manner will require MTI to provide us withits financial results and financial statements in a timely manner.  If MTI fails to timely produce its financialresults and financial statements, we may not be able to report our financialresults or comply with SEC reporting requirements.  In addition, if the officers of MTI are notable to make the certifications required under the Sarbanes-Oxley Act of 2002,or the Sarbanes-Oxley Act, and SEC rules, our officers may not be able to maketheir required certifications.  As aresult, we may be subject to SEC enforcement action and civil litigation, andour stock price may decline.

 

***If we become profitable, we cannot assureyou that our net operating losses will be available to reduce our taxliability.***

 

Ourability to use, or the amount of, our net operating losses, may be limited or reduced.  The businesses purchased by us in 2001 and2002 experienced “ownership changes” within the meaning of Section 382 ofthe Internal Revenue Code of 1986, as amended. Generally, a change of more than 50 percentage points in theownership of a company’s shares, by value, over the three-year period ending onthe date the shares were acquired constitutes an ownership change, and theseownership changes limit our ability to use the acquired company’s net operatinglosses.  Furthermore, the number of sharesof our common stock issued in our initial public offering may be sufficient,taking into account prior or future shifts in our ownership over a three-yearperiod, to cause us to undergo an ownership change.  As a result, our ability to use our existingnet operating losses that are not currently subject to limitation to offsetU.S. federal taxable income if we become profitable may also become subject tosubstantial limitations.  Further, theamount of our net operating losses could be reduced if any tax deductions takenby us are limited or disallowed by the Internal Revenue Service.  All of these limitations could potentiallyresult in increased future tax liability for us.

 

***One of our principal stockholders and itsaffiliates will be able to influence matters requiring stockholder approval andcould discourage the purchase of our outstanding shares at a premium.***

 

Asof November 1, 2005, Warburg Pincus beneficially owned approximately 76%of our outstanding common stock.  Thisconcentration of ownership may have the effect of delaying, preventing ordeterring a change in control of our company, could deprive our stockholders ofan opportunity to receive a premium for their common stock as part of a sale ormerger of our company and may negatively affect the market price of our commonstock. Transactions that could be affected by this concentration of ownershipinclude proxy contests, tender offers, mergers or other purchases of commonstock that could give you the opportunity to realize a premium over thethen-prevailing market price for shares of our common stock.

 

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Asa result of Warburg Pincus’ share ownership and representation on our board ofdirectors, Warburg Pincus is able to influence all affairs and actions of ourcompany, including matters requiring stockholder approval, such as the electionof directors and approval of significant corporate transactions.  The interests of our principal stockholdermay differ from the interests of the other stockholders.  For example, Warburg Pincus could oppose athird party offer to acquire us that our other stockholders might considerattractive, and the third party may not be able or willing to proceed unlessWarburg Pincus supports the offer.  Inaddition, if our board of directors supports a transaction requiring anamendment to our certificate of incorporation, Warburg Pincus is currently in aposition to defeat any required stockholder approval of the proposedamendment.  If our board of directorssupports an acquisition of us by means of a merger or a similar transaction,the vote of Warburg Pincus alone is currently sufficient to approve or blockthe transaction under Delaware law. In each of these cases and in similarsituations, you may disagree with Warburg Pincus as to whether the actionopposed or supported by Warburg Pincus is in the best interest of ourstockholders.

 

***Certain of our principal stockholders mayhave conflicts of interests with our other stockholders or us in the future.***

 

Certainof our principal stockholders, including Warburg Pincus, may make investmentsin companies and from time to time acquire and hold interests in businessesthat compete directly or indirectly with us. These other investments may:

 

•                                          create competing financial demands on ourprincipal stockholders;

 

•                                          create potential conflicts of interest; and

 

•                                          require efforts consistent with applicable lawto keep the other businesses separate from our operations.

 

These principal stockholdersmay also pursue acquisition opportunities that may be complementary to ourbusiness and, as a result, those acquisition opportunities may not be availableto us.  Furthermore, these principalstockholders may have an interest in our company pursuing acquisitions,divestitures, financings or other transactions that, in their judgment, couldenhance their equity investment, even though such transactions might involverisks to our stockholders.  In addition,these principal stockholders’ rights to vote or dispose of equity interests inour company are not subject to restrictions in favor of our company other thanas may be required by applicable law.

 

***We are a “controlled company” within the meaning of the NASDAQ NationalMarket System rules and, as a result, are exempt from certain corporate governancerequirements.***

 

Because Warburg Pincuscontrols more than 50% of the voting power of our common stock, we areconsidered to a “controlled company” for the purposes of the NASDAQ NationalMarket System quotation requirements.  Assuch, we are permitted, and have elected, to opt out of the NASDAQ NationalMarket System quotation requirements that would otherwise require our board ofdirectors to have a majority of independent directors, our board nominations tobe selected, or recommended for the board’s selection either by a nominatingcommittee comprised entirely of independent directors or by a majority of ourindependent directors and our compensation committee to be comprised entirelyof independent directors.  Accordingly,you may not have the same protections afforded to stockholders of companiesthat are subject to all of the NASDAQ National Market System corporategovernance requirements.

 

***Our corporate documents and Delaware law contain provisions that coulddiscourage, delay or prevent a change in control of our company.***

 

Provisions in our amended andrestated certificate of incorporation and amended and restated bylaws maydiscourage, delay or prevent a merger or acquisition involving us that ourstockholders may consider favorable.  Forexample, our amended and restated certificate of incorporation authorizes ourboard of directors to issue up to 100 million shares of “blank check”preferred stock.  Without stockholderapproval, the board of directors has the authority to attach special rights,including voting and dividend rights, to this preferred stock.  With these rights,

 

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preferred stockholders couldmake it more difficult for a third party to acquire us.  In addition, our amended and restatedcertificate of incorporation provides for a staggered board of directors,whereby directors serve for three year terms, with approximately one third ofthe directors coming up for reelection each year.  Having a staggered board makes it more difficultfor a third party to obtain control of our board of directors through a proxycontest, which may be a necessary step in an acquisition of us that is notfavored by our board of directors.

 

We are also subject to theanti-takeover provisions of Section 203 of the Delaware GeneralCorporation Law.  Under these provisions,if anyone becomes an “interested stockholder,” we may not enter into a “businesscombination” with that person for three years without special approval, whichcould discourage a third party from making a takeover offer and could delay orprevent a change of control.  Forpurposes of Section 203, “interested stockholder” means, generally,someone owning 15% or more of our outstanding voting stock or an affiliate ofours that owned 15% or more of our outstanding voting stock during the pastthree years, subject to certain exceptions as described in Section 203.  Under one such exception, Warburg Pincus doesnot constitute an “interested stockholder.”

 

***The requirements of being a public company may strain our resources anddistract management.***

 

As a public company, we aresubject to the reporting requirements of the Securities Exchange Act of 1934,as amended, or the Exchange Act, and the Sarbanes-Oxley Act.  These requirements may place a strain on ourpersonnel, systems and resources.  TheExchange Act requires, among other things, that we file annual, quarterly andcurrent reports with respect to our business and financial condition.  The Sarbanes-Oxley Act requires, among otherthings, that we maintain effective disclosure controls and procedures andinternal controls over financial reporting. In order to improve the effectiveness of our disclosure controls andprocedures and internal controls over financial reporting, significantresources and management oversight will be required.  This may divert management’s attention fromother business concerns, which could have a material adverse effect on ourbusiness, financial condition, results of operations and cash flows.

 

***We incur increased costs as a result of being a public company.***

 

As a public company, we incursignificant legal, accounting and other expenses that we did not incur as aprivate company.  In addition, theSarbanes-Oxley Act, as well as rules subsequently implemented by the SECand the NASDAQ National Market System, have required changes in our corporategovernance practices.  These rules andregulations have increased our legal and financial compliance costssignificantly and make some activities more time-consuming and costly.  For example, in anticipation of becoming apublic company, we created additional board committees and adopted policiesregarding internal controls and disclosure controls and procedures.  In addition, we incur additional costsassociated with our public company reporting requirements.  We also expect these rules andregulations to make it more difficult and more expensive for us to obtaindirector and officer liability insurance and we may be required to acceptreduced policy limits and coverage or incur substantially higher costs toobtain the same or similar coverage.  Asa result, it may be more difficult for us to attract and retain qualifiedpersons to serve on our board of directors or as executive officers.

 

***If we are unable tosuccessfully address the material weakness in our internal controls, ourability to report our financial results on a timely and accurate basis may beadversely affected.***

 

As of October 2, 2005, we did not maintain effective controls over the preparation, review and presentation and disclosure of our consolidated statement of cash flows. Specifically, we incorrectly reported an interest payment on demand notes payable as a financing cash out-flow instead of an operating cash out-flow in accordance with generally accepted accounting principles.  This control deficiency resulted in the restatement of our consolidated financial statements for the quarter ended July 3, 2005 and the quarter ended October 2, 2005.  Additionally, this control deficiency could result in a misstatement of the presentation and disclosure of our operating and financing cash flows in our consolidated financial statements that would result in a material misstatement to the annual or interim financial statements that would not be prevented or detected.  Accordingly, management determined that this control deficiency constitutes a material weakness in our internal control over financial reporting as of October 2, 2005.  A material weakness is a control deficiency or a combination of control deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected. Although we are taking steps to remediate the material weakness, we cannot assure that this control deficiency will not result in a misstatement in the future.  These steps include a thorough review of the classification requirements of each component line item and the individual elements that comprise each line item of the statement of cash flows, in accordance with generally accepted accounting principles.

 

In connection with theiraudits of our consolidated financial statements for the years ended December 31,2003 and 2004, our independent registered public accounting firm reported twoconditions, which together constituted a material weakness in our internalcontrol over financial reporting regarding our ability to produce financialstatements free from material misstatements. Our independent registered public accounting firm reported to us that wedid not have a sufficient number of senior level financial personnel, and ourcontrols over non-routine transactions did not ensure that accountingconsiderations were identified and appropriately recorded.  These two conditions, in combination, constituteda material weakness in our internal control over financial reporting.

 

Our management and auditcommittee agreed that the conditions identified by our independent registeredpublic accounting firm in their audits of the consolidated financial statementsfor the years ended December 31, 2003 and 2004 constituted a materialweakness.   We developed a plan toaddress this material weakness that included the addition of a new chieffinancial officer, a director of external reporting and additional professional

 

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accounting personnel.  On an interim basis, we engaged two seniorfinancial consultants in the fourth quarter of 2004 to provide an immediateexpansion in our technical finance and accounting resources.  These individuals were retained through June 2005to ensure adequate time for transition to our new full-time employees.  Effective April 2005, we hired a newchief financial officer, who has 19 years of experience in the medical devicemanufacturing industry working for both public and private companies.  We also hired a new controller in April 2005,who came to us from a Big Four public accounting firm and has significantexperience in both public and private accounting.  Our controller oversees external reportingwith assistance from a newly promoted senior analyst.  Our prior controller, who has been with usfor approximately four years, has become our Director of International Finance.  In May 2005, we added an additionalsenior staff level accounting position.  With the addition of these individuals, we believe that we have a sufficientnumber of skilled personnel to reasonably ensure that we have the ability toproduce financial statements free from material misstatements.  We have also engaged a consulting firm toassist us in assessing our internal control over financial reporting andremediating any control deficiencies. As a result of these measures, we haveconcluded that this latter material weakness that existed in our internalcontrol over financial reporting has been fully remediated as of October 2,2005. However, we will continue to assess the adequacy and appropriateness ofour financial staff and adjust accordingly as changes in our business warrant.

 

We cannot be certain thatadditional material weaknesses in our internal control over financial reportingwill not be discovered in the future. Any failure to remediate the unremediated material weakness describedabove or any future material weaknesses or to implement required new or improvedcontrols, or difficulties encountered in their implementation, could harm ouroperating results, cause us to fail to meet our reporting obligations or resultin material misstatements in our consolidated financial statements.  Any such failure also could adversely affectthe results of the periodic management evaluations and annual auditorattestation reports regarding the effectiveness of our “internal control overfinancial reporting” that will be required when the Securities andExchange Commission’s rules under Section 404 of the Sarbanes-OxleyAct become applicable to us beginning with our annual report on Form 10-Kfor the year ending December 31, 2006 to be filed in early 2007.   Inadequate internal control overfinancial reporting could also cause investors to lose confidence in ourreported financial information, which could cause our stock price to decline.

 

***We will be exposed to risks relating to evaluations of controlsrequired by Section 404 of the Sarbanes-Oxley Act.***

 

Changing laws, regulations andstandards relating to corporate governance and public disclosure, including theSarbanes-Oxley Act and related regulations implemented by the SEC and theNASDAQ National Market System, are creating uncertainty for public companies,increasing legal and financial compliance costs and making some activities moretime consuming.  We will be evaluatingour internal control over financial reporting to allow management to report on,and our independent registered public accountants to attest to, our internalcontrol over financial reporting.  Wewill be performing the system and process evaluation and testing (and anynecessary remediation) required to comply with the management certification andauditor attestation requirements of Section 404 of the Sarbanes-OxleyAct.  While we anticipate being able tofully implement the requirements of Section 404 by our December 31,2006 deadline, we cannot be certain as to the timing of completion of ourevaluation, testing and remediation actions or the impact of the same on ouroperations since there is presently no precedent available by which to measurecompliance adequacy.  If we are not ableto implement the requirements of Section 404 in a timely manner or withadequate compliance, we may be subject to sanctions or investigation byregulatory authorities, including the SEC or the NASDAQ National MarketSystem.  This type of action couldadversely affect our financial results or investors’ confidence in our companyand our ability to access capital markets, and could cause our stock price todecline.  In addition, the controls andprocedures that we will implement may not comply with all of the relevant rules andregulations of the SEC and the NASDAQ National Market System.  If we fail to develop and maintain effectivecontrols and procedures, we may be unable to provide the required financialinformation in a timely and reliable manner.

 

**ITEM 3.****    ****QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

We are exposed to variousmarket risks, which are potential losses arising from adverse changes in marketrates and prices, such as interest rates and foreign exchangefluctuations.  We do not enter intoderivatives or other financial instruments for trading or speculative purposes.

 

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***Interest Rate Risk***

 

We currently have littleexposure to a change in interest rates. Our borrowings to date have all been at a fixed rate of interest.  We have no variable rate debt or lease obligations.

 

***Foreign Currency Exchange Rate Risk***

 

Fluctuations in the rate ofexchange between the U.S. dollar and foreign currencies could adversely affectour financial results.  In the three andnine months ended October 2, 2005, approximately 32% and 36%,respectively, of our net sales were denominated in foreign currencies.  We expect that foreign currencies willcontinue to represent a similarly significant percentage of our net sales inthe future.  Selling, marketing andadministrative costs related to these sales are largely denominated in the samerespective currency, thereby limiting our transaction risk exposure.  We, therefore, believe that the risk of asignificant impact on our operating income from foreign currency fluctuationsis minimal.  However, for sales notdenominated in U.S. dollars, if there is an increase in the rate at which aforeign currency is exchanged for U.S. dollars, it will require more of theforeign currency to equal a specified amount of U.S. dollars than before therate increase.  In such cases and if weprice our products in the foreign currency, we will receive less in U.S.dollars than we did before the rate increase went into effect.  If we price our products in U.S. dollars andcompetitors price their products in local currency, an increase in the relativestrength of the U.S. dollar could result in our price not being competitive ina market where business is transacted in the local currency.

 

Approximately 68% of our netsales denominated in foreign currencies in both the three and nine months endedOctober 2, 2005, were derived from European Union countries and weredenominated in the Euro.  Additionally,we have significant intercompany receivables from our foreign subsidiaries,which are denominated in foreign currencies, principally the Euro.  Our principal exchange rate risk thereforeexists between the U.S. dollar and the Euro. Fluctuations from the beginning to the end of any given reporting periodresult in the remeasurement of our foreign currency-denominated receivables andpayables, generating currency transaction gains or losses that impact ournon-operating income/expense levels in the respective period and are reportedin other (income) expense, net in our consolidated financial statements.  We recorded a $77 thousand foreign currencytransaction gain and $3.0 million foreign currency transaction loss in thethree and nine months ended October 2, 2005, respectively, related to thetranslation of our foreign denominated net receivables into U.S. dollars.  We do not currently hedge our exposure toforeign currency exchange rate fluctuations. We may, however, hedge such exposure to foreign currency exchange ratesin the future.

 

**ITEM 4.****    ****CONTROLS AND PROCEDURES**

 

**Evaluation ofDisclosure Controls and Procedures**

 

We maintain disclosure controls and procedures (asdefined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended) that are designed to ensure that informationrequired to be disclosed by us in the reports we file or submit under theSecurities Exchange Act of 1934, as amended, is recorded, processed,summarized, and reported, within the time periods specified in the Securitiesand Exchange Commission’s rules and forms and that such information isaccumulated and communicated to our management, including our principalexecutive and principal financial officers, or persons performing similarfunctions, as appropriate to allow timely decisions regarding requireddisclosure.  In designing and evaluatingthe disclosure controls and procedures, we recognize that any controls andprocedures, no matter how well designed and operated can provide onlyreasonable assurance of achieving the desired control objectives and wenecessarily are required to apply our judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

 

Our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered in this quarterly report on Form 10-Q/A.  The evaluation of our disclosure controls and procedures by our Chief Executive Officer and Chief Financial Officer included a review of the restatement of our consolidated statement of cash flows for the nine months ended October 2, 2005 described in Item 1, Note 2 of this Form 10-Q/A.  Based on this evaluation and because of the material weakness related to our controls over the preparation, review and presentation and disclosure of our consolidated statement of cash flows described below, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of the end of the period covered in this quarterly report on Form 10-Q/A.  To address the material weakness described below related to our controls over the preparation, presentation and disclosure of our consolidated statement of cash flows, we have expanded our disclosure controls and procedures to include additional analysis and other procedures over the preparation of the financial statements included in this Form 10-Q/A.  Accordingly, our management has concluded that the financial statements included in this Form 10-Q/A fairly present in all material respects our financial condition, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles.

 

A material weakness is a control deficiency or a combination of control deficiencies that results in more than a remote likelihood that a material misstatement of the annual or interim consolidated financial statements will not be prevented or detected. As of October 2, 2005, we did not maintain effective controls over the preparation, review and presentation and disclosure of our consolidated statement of cash flows. Specifically, we incorrectly reported an interest payment on demand notes payable as a financing cash out-flow instead of an operating cash out-flow, in accordance with generally accepted accounting principles. This control deficiency resulted in the restatement of our consolidated financial statements for the quarter ended July 3, 2005 and the quarter ended October 2, 2005. Additionally, this control deficiency could result in a misstatement of the presentation and disclosure of our operating and financing cash flows in our consolidated financial statements that would result in a material misstatement in our annual or interim consolidated financial statements that would not be prevented or detected. Accordingly, management determined that this control deficiency constitutes a material weakness in our internal control over financial reporting as of October 2, 2005.

 

**Changes in Internal Control OverFinancial Reporting**

 

In connection with theiraudits of our consolidated financial statements for the years ended December 31,2003 and 2004, our independent registered public accounting firm reported twoconditions, which together constitute a material weakness in our internalcontrol over financial reporting regarding our ability to produce financialstatements free from material misstatements. Our independent registered public accounting firm reported to our Board ofDirectors that we did not have a sufficient number of senior level financialpersonnel, and our controls over non-routine transactions did not ensure thataccounting considerations are identified and appropriately recorded.  These two conditions, in combination,constituted a material weakness in our internal control over financialreporting.

 

We developed a plan to addressthis material weakness that included the addition of a new chief financialofficer, a director of external reporting and additional professionalaccounting personnel.  On an interimbasis, we engaged two senior financial consultants in the fourth quarter of2004 to provide an immediate expansion in our technical finance and accountingresources.  These individuals wereretained through June 2005 to ensure adequate time for transition to ournew full-time employees.  We hired a newchief financial officer, effective April 2005, who has 19 years ofexperience in the medical device manufacturing industry working for both publicand private companies.  We also hired anew controller in April 2005, who came to us from a Big Four publicaccounting firm and has significant experience in both public and privateaccounting.  Our controller overseesexternal reporting with assistance from a newly promoted senior analyst.  Our prior controller, who has been with usfor approximately four years, has become our Director of InternationalFinance.  In May 2005, we added anadditional senior staff level accounting position.   With the addition of these individuals, webelieve that we have sufficient, skilled personnel to reasonably ensure that wehave the ability to produce financial statements free from materialmisstatements.  We have also engaged aconsulting firm to assist us in assessing our internal control over financialreporting and remediating any control deficiencies.  As a result of these measures, we have concludedthat the material weakness that existed in our internal control over financialreporting as of December 31, 2004 has been fully remediated as of October 2,2005. However, we will continue to assess the adequacy and appropriateness ofour financial staff and adjust accordingly as changes in our business warrant.

 

Except as described above,there was no change in our internal control over financial reporting thatoccurred during our quarter ended October 2, 2005 that has materiallyaffected, or is reasonably likely to materially affect, our internal controlover financial reporting.  

 

**Plan for Remediation of Material Weakness**

 

Management is taking steps to remediate the material weakness in our internal control over financial reporting relating to the presentation of our cash flows. These steps include a thorough review of the classification requirements of each component line item and the individual elements that comprise each line item of the statement of cash flows, in accordance with generally accepted accounting principles.  Management believes the additional control procedures designed, and when implemented will fully remediate this material weakness.  Although we are not certain when the material weakness will be fully remediated, we will need a period of time over which to demonstrate that these controls are functioning appropriately to conclude that we have adequately remediated the material weakness.

 

**PART II- OTHER INFORMATION**

 

**ITEM 1.****    ****LEGAL PROCEEDINGS**

 

We are from time to timesubject to, and are presently involved in, litigation or other legalproceedings.

 

In September 2000,Dendron, which was acquired by MTI in 2002, was named as the defendant in threepatent infringement lawsuits brought by the Regents of the University ofCalifornia, as the plaintiff, in the District Court (Landgericht) inDusseldorf, Germany.  The complaintsrequested a judgment that Dendron’s EDC I coil device infringed three Europeanpatents held by the plaintiff and asked for relief in the form of an injunctionthat would prevent Dendron from producing and selling the devices withinGermany and selling from Germany to physician customers abroad, as well as anaward of damages caused by Dendron’s alleged infringement, and other costs,disbursements and attorneys’ fees.  In August 2001,the court issued a written decision that EDC I coil devices did infringe theplaintiff’s patents, enjoined Dendron from selling the devices within Germanyand from Germany to physician customers abroad, and requested that Dendrondisclose the individual products’ costs as the basis for awarding damages.  In September 2001, Dendron appealed thedecision.  In addition, Dendroninstituted challenges to the validity of each of these patents by filingopposition proceedings with the European Patent Office, or EPO, against one ofthe patents (MTI joined Dendron in this action in connection with itsacquisition of Dendron), and by filing, with MTI, nullity proceedings with theGerman Federal Patents Court against the German component of the other twopatents.  The opposition proceedings withthe EPO on the one patent are complete, and the EPO has rejected the oppositionand has upheld the validity of the one patent.

 

On July 4, 2001, theUniversity of California filed another suit against Dendron alleging that theEDC I coil device infringed another European patent held by theplaintiff.  The complaint was filed inthe District Court of Dusseldorf,

 

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Germany seeking additionalmonetary and injunctive relief.  In April 2002,the Court found that EDC I coil devices did infringe the plaintiff’spatent.  The patent involved is the samepatent that was involved in the case before the English Patents Court discussedbelow and that was ruled by a Dutch court to be invalid, also discussedbelow.  The opposition proceedings on thepatent are complete, and the EPO has rejected the opposition and has upheld thevalidity of the patent.  The case isunder appeal and an oral hearing is scheduled to be held in the DusseldorfCourt of Appeal on March 9, 2006.

 

An accrual for the mattersdiscussed above was included in the balance sheet of Dendron as of the date ofits acquisition by MTI. As of October 2, 2005, approximately $800 thousandwas recorded in accrued liabilities in our consolidated financial statementsincluded in this report.  Dendron ceasedall activities with respect to the EDC I coil device prior to MTI’s October 2002acquisition of Dendron.

 

Concurrent with itsacquisition of Dendron, MTI initiated a series of legal actions related to itsSapphire coils in the Netherlands and the United Kingdom, which included across-border action that was heard by a Dutch court, as further describedbelow.  The primary purpose of theseactions was to assert both invalidity and non-infringement by MTI of certainpatents held by others.  The range ofpatents at issue are held by the Regents of the University of California, withBoston Scientific Corporation subsidiaries named as exclusive licensees,collectively referred to as the «patent holders,» related to detachable coilsand certain delivery catheters.

 

In October 2003, theDutch court ruled the three patents at issue related to detachable coils arevalid and that MTI’s Sapphire coils do infringe such patents.  The Dutch court also ruled that the patentholders’ patent at issue related to the delivery catheter was invalid.  Pursuant to the court’s ruling, MTI has beenenjoined from engaging in infringing activities related to the Sapphire coilsin most countries within the European Union, and may be liable forthen-unspecified monetary damages for activities engaged in by MTI since September 27,2002.  In February 2005, MTIreceived an initial claim from the patent holders with respect to monetarydamages, amounting to €3.6 million, or approximately $4.3 million as of October 2,2005, with which MTI disagrees.  Courthearings will be held regarding these claims. MTI has filed an appeal with the Dutch court, and believes that sincethe date of injunction in each separate country it is in compliance with theDutch court’s injunction and MTI intends to continue such compliance. Becausewe believe that MTI has valid legal grounds for appeal, we have determined thata loss is not probable at this time as defined by SFAS 5, *Accounting for Contingencies.*  However, there can be no assurance that theultimate resolution of this matter will not result in a material adverse effecton our business, financial condition or results of operations.

 

In January 2003, MTIinitiated a legal action in the English Patents Court seeking a declarationthat a patent held by the patent holders related to delivery catheters wasinvalid, and that MTI’s products did not infringe this patent.  The patent in question was the U.K.designation of the same patent that was found by the Dutch court in October 2003to be invalid, as discussed above.  Thepatent holders counterclaimed for alleged infringement by MTI. In February 2005,the court approved an interim settlement between the parties under which the patentholders are required to surrender such patent to the U.K. Comptroller ofPatents, and to pay MTI’s costs associated with the legal action, includinginterest.  As a result, MTI receivedinterim payments from the patent holders aggregating £500 thousand (equivalentto approximately $900 thousand based on the dates of receipt), which MTIrecorded as a reduction of litigation expense upon receipt of such funds in February andMarch 2005.  The parties intend tocontinue discussions regarding payment by the patent holders of the remainingcosts incurred by MTI in such litigation. As a result of the interim settlement, MTI anticipates that it will nolonger be involved in litigation in the United Kingdom, although no assurancecan be given that no other litigation involving MTI may arise in the UnitedKingdom.

 

In the United States,concurrent with the FDA’s marketing clearance of the Sapphire line of emboliccoils received in July 2003, MTI initiated a declaratory judgment actionagainst the patent holders in the United States District Court for the WesternDistrict of Wisconsin.  The actionincluded assertions of non-infringement by MTI and invalidity of a range ofpatents held by the patent holders related to detachable coils and certaindelivery catheters.  In October 2003,the court dismissed MTI’s actions for procedural reasons without prejudice andwithout decision as to the merits of the parties’ positions.  In December 2003, the University ofCalifornia filed an action against MTI in the United States District Court forthe Northern District of California alleging infringement by MTI with respectto a range of patents held by the University of California related todetachable coils and certain delivery systems. MTI has filed a counterclaimagainst the University of California asserting non-infringement by MTI,invalidity of the

 

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patents and inequitableconduct in the procurement of certain patents. In addition, MTI filed a claim against the University of California andBoston Scientific Corporation for violation of federal antitrust laws, with theresult that the court has subsequently decided to add Boston Scientific as aparty to the litigation.  A trial date hasnot been set. Because these matters are in early stages, we cannot estimate thepossible loss or range of loss, if any, associated with their resolution.  However, there can be no assurance that theultimate resolution of these matters will not result in a material adverseeffect on our business, financial condition or results of operations.

 

In March 2005, Medtronic, Inc.contacted us to express its view that our Protégé stents infringe on one ormore of its patents. We informed Medtronic that we disagree with itsassertions, and have since had several discussions with Medtronic.  No lawsuit with respect to this matter hasbeen filed. We also received notice from an individual claiming that hebelieves that our PLAATO device infringes on two of his patents.  We have informed this individual that we donot believe that our PLAATO device infringes on these patents.  We have also informed this individual of ourdecision to discontinue the development and commercialization of the PLAATOdevice.  On March 30, 2005, we wereserved with a complaint by Boston Scientific Corporation and one of itsaffiliates which claims that some of our products, including our SpideRXEmbolic Protection Device, infringe certain of Boston Scientific’spatents.  This action was brought in theUnited States District Court for the District of Minnesota.  We have answered the complaint and intend tovigorously defend this action. Because these matters are in early stages, wecannot estimate the possible loss or range of loss, if any, associated withtheir resolution.  However, there can beno assurance that the ultimate resolution of these matters will not result in amaterial adverse effect on our business, financial condition or results ofoperations.

 

The acquisition agreementrelating to our acquisition of Appriva Medical, Inc. contains fourmilestones to which payments relate. The first milestone was required byits terms to be achieved by January 1, 2005 in order to trigger a paymentequal to $50 million.  We have determined that the first milestonewas not achieved by January 1, 2005 and that the first milestone is notpayable. On May 20, 2005, Michael Lesh, as an individual sellerof Appriva stock and purporting to represent certain othersellers of Appriva stock, filed a complaint in the Superior Court ofthe State of Delaware with individually specified damages aggregating$70 million and other unspecified damages for several allegations,including that we, along with other defendants, breached the acquisitionagreement and an implied covenant of good faith and fair dealing by willfullyfailing to take the steps necessary to meet the first milestone under theagreement, and thereby also failing to meet certain other milestones, andfurther that one milestone was actually met. The complaint also alleges fraud,negligent misrepresentation and violation of state securities laws inconnection with the negotiation of the acquisition agreement.  We believethese allegations are without merit and intend to vigorously defend thisaction. We filed a motion to dismiss the complaint.  A hearing is expected to be held on thismotion in January 2006. The parties have not engaged in anydiscovery.  On August 5, 2005, ourattorneys received a letter from attorneys representing certain other sellersof Appriva stock (who are not purported to be represented in the action filedby Lesh), asking our attorneys to enter into a dialogue regarding theirassertions that certain milestones should have been paid. We believe theirassertions are without merit. Failure to reach agreement with these newclaimants on a resolution of our differences could lead to additionallitigation on this matter.  Because these matters are in an early stages,we cannot estimate the possible loss or range of loss, if any, associated withtheir resolution. However, there can be no assurance that the ultimateresolution of these matters will not result in a material adverse effect on ourbusiness, financial condition or results of operations.

 

On October 11, 2005, apurported stockholder class action lawsuit related to our proposal to acquireall of the outstanding shares of common stock of our majority-owned subsidiary,Micro Therapeutics, Inc., that we do not already own, was filed in theCourt of Chancery of the State of Delaware, in and for New Castle County,Delaware, naming MTI and each of its directors and ev3 as defendants.  The complaint alleges that the defendantshave and are breaching their fiduciary duties to the detriment of MTI’sstockholders by, among other things, denying MTI’s public stockholders the opportunityto obtain fair value for their equity interests by proposing a transaction atan inadequate premium.  The complaintseeks the following relief: (1) certification of the lawsuit as a classaction; (2) an injunction preventing the completion of the proposedtransaction; (3) rescission of the proposed transaction or rescissorydamages to the extent the proposed transaction is already implemented prior tofinal judgment; (4) compensation for the plaintiff and other members ofthe class for all damages sustained as a result of the defendants’ conduct; (5) directingthat the defendants account to the plaintiff and other members of the class forall profits and any special benefits obtained as a result of their conduct; (6) costsand disbursements of the lawsuit, including attorneys’ fees and expenses; and (7) suchother relief as the court may find just and proper.  ev3 believes this lawsuit is without meritand plans to defend it vigorously. Because this matter is in an early stage, we cannot

 

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estimate the possible loss orrange of loss, if any, associated with the resolution.  However, there can be no assurance that theultimate resolution of this matter will not result in a material adverse effecton our business, financial condition or results of operations.

 

**ITEM 2.****                                                    ****UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS**

 

**Recent Salesof Unregistered Equity Securities**

 

We issued 31,500 shares of ourcommon stock to various current and former employees during the quarter ended October 2,2005 pursuant to the exercise of options to purchase shares of our common stockunder the ev3 LLC 2003 incentive plan. Except for these issuances, there were no other unregistered sales by usof our equity securities during the quarter ended October 2, 2005.

 

No underwriting commissions ordiscounts were paid with respect to the sales of the unregistered securitiesdescribed above.  In addition, all of theabove sales were made in reliance on Rule 701, Regulation D and Section 4(2) underthe Securities Act of 1933, as amended (the “Securities Act”).  With regard to our reliance upon theexemptions under Regulation D and Section 4(2) under the SecuritiesAct, certain inquiries of the purchasers were made by us to establish that suchsales qualified for such exemptions from the registration requirements.  With regard to our reliance upon the Rule 701exemption, all such issuances were to employees, former employees orindependent consultants.

 

**Use ofProceeds**

 

On June 15, 2005, ourregistration statement on Form S-1 (Registration No. 333-123851) wasdeclared effective.  Our initial publicoffering resulted in gross proceeds to us of $167.6 million.  Expenses related to the initial publicoffering were as follows:  approximately$8.4 million for underwriting discounts and commissions and approximately $4.2million for other expenses, for total expenses of approximately $12.6million.  None of the offering expensesresulted in direct or indirect payments to any of our directors, officers ortheir associates, to persons owning 10% or more of our common stock or to anyof our affiliates.  All of the offeringexpenses were paid to others.

 

After deduction of offeringexpenses, we received net proceeds of approximately $154.9 million in ourinitial public offering, including shares sold by us pursuant to theunderwriters’ over-allotment option.  Asof October 2, 2005, the proceeds from our initial public offering andavailable cash were used as follows: $36.5 million of the net proceeds were used to repay a portion of theaccrued and unpaid interest on the demand notes, $18.9 million for generalcorporate purposes and the remaining net proceeds were invested in short-term,investment-grade, interest bearing securities. We cannot predict whether the proceeds will yield a favorable return.Other than $36.5 million of the net proceeds used to repay a portion of theaccrued and unpaid interest on demand notes held by Warburg Pincus, which isour majority stockholder, and Vertical, which is one of our stockholders, noneof the net proceeds from our initial public offering have resulted in direct orindirect payments to directors, officers or their associates, to persons whoowned 10% or more of our common stock or to any of our affiliates.

 

We expect to use the remaining$99.5 million in net proceeds from our initial public offering for generalcorporate purposes, which may include funding the operations of MTI.  We do not currently have any more specificplans with respect to the use of these net proceeds.  Our management has broad discretion as to theuse of the net proceeds.  While we have no present understandings,commitments or agreements to enter into any potential acquisitions, we may usea portion of the net proceeds for the acquisition of, or investment in,technologies or products that complement our business.  As required bySecurities and Exchange Commission regulations, we will provide further detailon our use of the net proceeds from our initial public offering in future periodicreports.

 

**IssuerPurchases of Equity Securities**

 

We did not purchase any sharesof our common stock or other equity securities registered pursuant to Section 12of the Securities Exchange Act of 1934, as amended, during the quarter ended October 2,2005, and our board of directors has not authorized any repurchase plan orprogram for purchase of our shares of common stock or other equity securitieson the open market or otherwise.

 

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**ITEM 3.****    ****DEFAULTS UPON SENIORSECURITIES**

 

Not applicable.

 

**ITEM 4.****    ****SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

 

Not applicable.

 

**ITEM 5.****    ****OTHER INFORMATION**

 

Not applicable.

 

**ITEM 6.****    ****EXHIBITS**

 

The following exhibits arebeing filed or furnished with this quarterly report on Form 10-Q:

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                |
|----------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                  |       | Amended and Restated Bylaws  of ev3 Inc. (Incorporated by reference to Exhibit 3.3 to ev3’s  Quarterly Report on Form 10-Q for the quarter ended July 3, 2005  (File No. 000-51348))                                                             |
| 10.1                 |       | ev3 Inc. Amended and Restated  2005 Incentive Stock Plan (Incorporated by reference to Exhibit 10.4 to  ev3’s Quarterly Report on Form 10-Q for the quarter ended July 3,  2005 (File No. 000-51348))                                                 |
| 10.2                 |       | Lease Agreement dated August 22,  2005 between Liberty Property Limited Partnership and ev3 Inc. (Incorporated  by reference to Exhibit 10.2 to ev3’s Quarterly Report on Form 10-Q  for the quarter ended October 2, 2005 (File No. 000-51348)) |
| 10.3                 |       | Form of Non-Statutory  Option Grant Notice under ev3 Inc. 2005 Incentive Stock Plan (Incorporated by  reference to Exhibit 10.3 to ev3’s Quarterly Report on Form 10-Q  for the quarter ended October 2, 2005 (File No. 000-51348))              |
| 31.1                 |       | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 and SEC Rule 13a-14(a) (Filed herewith)                                                                                                                    |
| 31.2                 |       | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 and SEC Rule 13a-14(a) (Filed herewith)                                                                                                                    |
| 32.1                 |       | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished  herewith)                                                                                            |
| 32.2                 |       | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Furnished  herewith)                                                                                            |

 

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**SIGNATURES**

 

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused this AmendmentNo. 1 on Form 10-Q/A to our Quarterly Report on Form 10-Q for thequarter ended October 2, 2005 to be signed on its behalf by the undersigned, hereunto duly authorized.

 
| February 24, 2006 | **ev3 Inc.** |
|------------------------|--------------|
|                   |         |   |
|                   | By:          | /s/ James M. Corbett |   |
|                   |         | James M. Corbett |
|                   |         | President and Chief  Executive Officer |
|                   |         | (principal executive officer) |
|                   |         |   |
|                   | By:          | /s/ Patrick D. Spangler |   |
|                   |         | Patrick D. Spangler |
|                   |         | Chief Financial Officer and  Treasurer |
|                   |         | (principal financial and  accounting officer) |

 

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**ev3 Inc.**

**QUARTERLY REPORT ON FORM 10-Q**

**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                               | ** ** | **Method of Filing**                                                                                                                                                  |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                  |       | Amended and Restated Bylaws  of ev3 Inc.                                                                                                                 |       | Incorporated by reference to Exhibit 3.3 to ev3’s Quarterly Report  on Form 10-Q for the quarter ended July 3, 2005 (File No. 000-51348)     |
| 10.1                 |       | ev3 Inc. Amended and Restated  2005 Incentive Stock Plan                                                                                                      |       | Incorporated by reference to Exhibit 10.4 to ev3’s Quarterly Report  on Form 10-Q for the quarter ended July 3, 2005 (File No. 000-51348)    |
| 10.2                 |       | Lease Agreement dated August 22,  2005 between Liberty Property Limited Partnership and ev3 Inc.                                                         |       | Incorporated by reference to Exhibit 10.2 to ev3’s Quarterly Report  on Form 10-Q for the quarter ended October 2, 2005 (File No. 000-51348) |
| 10.3                 |       | Form of Non-Statutory  Option Grant Notice under ev3 Inc. 2005 Incentive Stock Plan                                                                      |       | Incorporated by reference to Exhibit 10.3 to ev3’s Quarterly Report  on Form 10-Q for the quarter ended October 2, 2005 (File No. 000-51348) |
| 31.1                 |       | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 and SEC Rule 13a-14                            |       | Filed herewith.                                                                                                                                                       |
| 31.2                 |       | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002 and SEC Rule 13a-14                            |       | Filed herewith.                                                                                                                                                       |
| 32.1                 |       | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |       | Furnished herewith.                                                                                                                                                   |
| 32.2                 |       | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |       | Furnished herewith.                                                                                                                                                   |

 

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