**UNITED STATES**SECURITIESAND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

 

**FORM 10-Q**

 

**(Mark one)**

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

 

**For the quarterly period ended October 2,2005**

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

 

**For thetransition period from                   to                   .**

 

**Commission file number:  000-51348**

 

**ev3 Inc.**

(Exact name of registrant as specified in its charter)

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

 

**4600Nathan Lane NorthPlymouth, Minnesota 55442**

(Address of principal executive offices)

 

**(763)398-7000**

(Registrant’s telephone number including area code)

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days. YES ý  NO  o

 

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

 

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

 

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

 

 

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**ev3Inc.**

**FORM 10-Q**

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

 

**TABLE OF 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 thisreport, references to “ev3,” “the company,” “we,” “our” or “us,” unless thecontext otherwise requires, refer to ev3 Inc. and its subsidiaries.*

 

*Alltrademarks or trade names referred to in this report are the property of theirrespective owners.*

 

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

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

 

**ev3 Inc.CONSOLIDATED BALANCE 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.CONSOLIDATED STATEMENTS OFOPERATIONS***(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 per common shareattributable to common stockholders and the weighted average common sharesoutstanding reflect the June 21, 2005 1-for-6 reverse stock split for allperiods presented.

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

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**ev3 Inc.CONSOLIDATED STATEMENTS OF CASHFLOWS ***(Dollarsin thousands, except per share amounts)******(unaudited)*

 
| ** **                                                                                            | ** ** | **Nine Months Ended**     | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|
| ** **                                                                                            | ** ** | **October 2,  2005** | ** ** | **October 3,  2004** | ** ** |
| **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 |   |
| Accrued interest on notes payable                                                                     |       | 12,156                    |       | 13,660 |   |
| Net cash  used in operating activities                                                                |       | (74,296                   | )          | (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 |   |
| Payments on  demand notes payable                                                                     |       | (36,475                   | )          | — |   |
| 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                                                            |       | 168,796                   |       | 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    |   | $ | — |   |

 

*The accompanying notes are an integral part of theseconsolidated financial statements.*

 

3

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**ev3 Inc.NOTES TO CONSOLIDATED FINANCIALSTATEMENTS***(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 two businesssegments: cardio peripheral and neurovascular. We manage our business andreports 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 TheVertical Group L.P. and certain of its affiliates (collectively “Vertical”)contributed all of the shares of MTI’s common stock directly owned by them toev3 LLC in exchange for common membership units. These common membership unitswere subsequently converted into shares of ev3 Inc. common stock in connectionwith a subsequent merger of ev3 LLC with and into ev3 Inc. on June 21,2005.  As a result of this merger, ev3Inc. became the holding company of ev3 LLC’s subsidiaries. The merger of ev3LLC with and into ev3 Inc. was accounted for as a combination under commoncontrol with the result that the financial statements for all periods presentedwere such that the historical financial statements of the group were carriedforward 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

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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.

 

Prior to the consummation of our initial publicoffering on June 21, 2005, we amended and restated our certificate ofincorporation to authorize 100,000,000 shares of common stock, par value $0.01per share, and 100,000,000 shares of preferred stock, par value $0.01 pershare.  On June 21, 2005,immediately prior to our initial public offering, we completed a one-for-sixreverse stock split of our outstanding common stock.  All share and per share amounts for allperiods 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.

 

**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 AccountingPronouncements**

 

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 andshare amounts)*

 
| ** **                                                                        | ** ** | **Units**      | ** ** | **Members’  Capital** | ** ** | ** **  | ** **     | ** ** | ** ** | **Additional  Paid In  Capital** | ** ** | **Accumulated  Other  Comprehensive  Income (Loss)** | ** **  | **Accumulated  Deficit** | ** ** | **Total  Stockholders’  Deficit** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------|------------|----------------------------|------------|-------------|----------------|------------|------------|----------------------------------|------------|------------------------------------------------------|-------------|--------------------------|------------|----------------------------------------|------------|
| ** **                                                                        | ** ** | ** **     |
| **Common Stock**                                                                  |
| **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 the appropriateclassification of our investments in securities at the time of purchase andreevaluates 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

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*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 agreementsrelating to the 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. On September 29, 2004, we sold substantially allof the assets constituting the MitraLife business to Edwards Lifesciences and areno longer pursuing commercialization of the product line acquired in theMitraLife transaction.  As of the datethat we sold these assets to Edwards Lifesciences, none of the milestones setforth in our agreement 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 agreementwas not achieved by the January 1, 2005milestone 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 theacquisition of Dendron on October 4, 2002, MTI terminated thethen-existing distribution agreements with substantially all of Dendron’sdistributors. One such distributor has indicated its intent to pursue what itbelieves are its rights against MTI, however, the amount that might be soughtby such distributor is unknown. MTI believes it has satisfied its obligationsto all the former Dendron distributors, and, accordingly, believes that lossesfrom future claims, if any, are not probable as defined by SFAS No. 5 “Accountingfor Contingencies”.

 

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

 

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) in Dusseldorf,Germany.  The complaints requested ajudgment that Dendron’s EDC I coil device infringed three European patents heldby the plaintiff and asked for relief in the form of an injunction that wouldprevent Dendron from producing and selling the devices within Germany andselling from Germany to physician customers abroad, as well as an award ofdamages 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, Germany seeking additional monetary andinjunctive 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

 

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be invalid, as discussedabove.  The patent holders counterclaimedfor alleged infringement by MTI. In February 2005, the court approved aninterim settlement between the parties under which the patent holders arerequired to surrender such patent to the U.K. Comptroller of Patents, and topay MTI’s costs 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’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 patents and inequitable conduct in the procurement of certainpatents.  In addition, MTI filed a claimagainst the University of California and Boston Scientific Corporation forviolation 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 us to express its view that our Protégé stentsinfringe on one or more of its patents. We informed Medtronic that we disagreewith its assertions, and have since had several discussions withMedtronic.  No lawsuit with respect tothis matter has been filed. We also received notice from an individual claimingthat he believes 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 individualseller of Appriva stock and 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 thisaction.  We filed a motion to dismiss the complaint.  A hearing is expected to be held on thismotion in January 2006.  The partieshave not engaged in any discovery.  On August 5,2005, our attorneys received a letter from attorneys representing certain othersellers of Appriva stock (who are not purported to be represented in the actionfiled by Lesh), asking our attorneys to enter into a dialogue regarding theirassertions

 

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that certain milestones shouldhave been paid. We believe their assertions 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 stage, wecannot 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 10, 2005, weannounced 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 andon November 14, 2005 we announced that we and MII had entered into an Agreementand Plan of Merger with MTI. (SeeNote 19).  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 Inc. 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 theopportunity 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 theultimate resolution of this matter will not result in a material adverse effecton our business, financial condition or results of operations.

 

**17. Segment and Geographic Information**

 

 *The following is segment and geographicinformation (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) Gross profit forinternal measurement purposes is defined as net sales less cost of goods soldexcluding 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**

 

The following outstanding convertible preferred unitsof ev3 LLC, convertible demand notes, and options to purchase shares of ourcommon stock and common membership interests of ev3 LLC were excluded from thecomputation of diluted net loss per share as they had an antidilutiveeffect.  In connection with the merger ofev3 LLC with and into ev3 Inc. immediately prior to our initial publicoffering, each preferred membership unit of ev3 LLC was converted into a shareof ev3 Inc. common stock and each option to purchase common membership units ofev3 LLC was converted into an option to purchase an equivalent number of sharesof our common 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, weannounced 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. We currentlyown 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 that this transactionwill be completed on these terms or at all. As discussed in Note 16, on October 11, 2005, a purportedstockholder class action lawsuit related to our proposal to acquire all of theoutstanding shares of MTI common stock, was filed in the Court of Chancery ofthe 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 five yearscommencing on the date that the Landlord substantially completes improvementsto the 9775 Premises as set forth in the lease. The lease provides MTI with anoption to extend the term of the lease for an additional six years. The basicrental amount for the 9775 Premises is initially $68 thousand per month andincreases annually over the term of the lease up to a maximum of $93 thousandper 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 report maycontain 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.

 

**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 corporateinfrastructure and direct sales capabilities in the United States, Canada,Europe and Japan and have established distribution relationships in other largeinternational markets.  Our corporateheadquarters is located in Plymouth, Minnesota and contains manufacturing,research and development, and U.S. sales operations for our peripheral vascularand cardiovascular 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 havefocused on building our U.S. and international direct sales and marketinginfrastructure that included a sales force of 198 direct sales representativesas of October 2, 2005 in the United States, Canada, Europe and Japan.  Direct sales representatives accounted forapproximately 88.0% of our net sales during the three and the nine months endedOctober 2, 2005, respectively, with the balance generated by independentdistributors.  In 2004,****we increased our U.S. direct sales forcefrom 44 to 82 and our Japan sales force from four to eleven.  In order to drive sales growth, we haveinvested heavily throughout our history in new product development, clinicaltrials to obtain regulatory approvals and the expansion of our globaldistribution system.  As a result, our costsand expenses have significantly exceeded our net sales, resulting in anaccumulated deficit of $540.7 million at October 2, 2005.  Consequently, we have financed our operationsthrough debt and equity offerings.  Weexpect to continue to generate operating losses for at least the next 12months.

 

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 overallmarket for endovascular devices will grow as the demand for minimally invasivetreatment of vascular diseases and disorders continues to increase. Our broadproduct portfolio is focused on applications that we estimate represented anaddressable worldwide endovascular market opportunity of approximately$1.6 billion in 2004. We intend to capitalize on this market opportunityby the continued introduction of new products. We intend to originate these newproducts primarily through our internal research and development and clinicalefforts, but we may supplement them with acquisitions or other externalcollaborations. Additionally, our growth has been, and will continue to be,impacted by our expansion into new geographic markets and the expansion of ourdirect sales organization in existing geographic markets.

 

We report and manage our operations in tworeportable business segments based on similarities in the products sold,customer base and distribution system.  Ourcardio peripheral segment contains products that are used in bothcardiovascular and peripheral vascular procedures by cardiologists,radiologists and vascular surgeons.  Ourneurovascular segment contains products that are used primarily byneuro-radiologists and neurosurgeons.  Oursales activities and operations are aligned closely with our businesssegments.  We generally have dedicatedcardio peripheral sales teams in the United States and Europe that targetcustomers who often perform procedures in both anatomic areas (cardiovascularand peripheral vascular).  We generallyhave separate, dedicated neurovascular sales teams in the United States andEurope that are specifically focused on this customer base.

 

MTI, our public operatingsubsidiary, is focused on the neurovascular market.  However, a small portion of MTI’s salesrelate to products sold into the cardio peripheral market, which we classify ascardio peripheral sales in our reporting. In addition, some of MTI’s sales are generated at a transfer price to ourinternational sales entities where they are resold by our salesorganization.  For consolidatedreporting, these intercompany sales are eliminated.  As a result, our neurovascular sales will bedifferent from the sales that MTI reports publicly.  Based on MTI’s public financial statements,approximately 42.1% of our net sales and 8.4% of our net losses during thethree months ended October 2, 2005 and 41.6% of our net sales and 4.5% of ournet losses during the nine months ended October 2, 2005 were attributableto MTI.

 

On January 28,2005, ev3 Inc. was formed as a subsidiary of ev3 LLC.  Immediately prior to the closing of ourinitial public offering on June 21, 2005, ev3 LLC merged with and into ev3Inc., and ev3 Inc. became the holding company for all of ev3 LLC’ssubsidiaries.  Warburg Pincus andVertical directly owned an aggregate of 9,704,819 shares of MTI’s common 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.

 

Immediately prior to the consummation of our initialpublic offering, we completed a one-for-six reverse stock split of ouroutstanding common stock.  All share andper share amounts for all periods presented in this report reflect this split.

 

On October 10, 2005, we announced that we had delivered a proposal toMTI to acquire all of the outstanding shares of common stock of MTI that we donot already own. We currently own approximately 70.1% of MTI’s outstandingcommon stock. On November 14, 2005, we and MII entered into an Agreement and Planof Merger with MTI pursuant to which we would acquire the shares of MTI that wedo not already own at an exchange ratio of 0.476289 of a share of our commonstock for each outstanding share of MTI common stock. Under the terms of the merger,we would issue approximately 6.9 million new shares of our common stock,bringing our total pro forma outstanding shares to approximately 56.1 million. Inaddition, we would assume all of the outstanding options to purchase MTI commonstock under MTI’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 onsale of assets, net includes the difference between the proceeds received fromthe sale 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)         The accretion of preferred membership units toredemption value presented above is based on the rights to which the Class Aand Class B preferred membership unit holders of ev3 LLC were entitledrelated to a liquidation, dissolution or winding up of ev3 LLC. Notwithstandingthis accretion right, in connection with the merger of ev3 LLC with and into us,each membership unit representing a preferred equity interest in ev3 LLC wasconverted into the right to receive one share of our common stock and did notreceive any additional 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 salesof cardio peripheral products.*    Net sales of our cardio peripheral productsincreased 64.7% to $19.8 million in the three months ended October 2, 2005compared to $12.0 million in the three months ended October 3, 2004. Thissales 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 bysales declines in older generation products. Net sales of our thrombectomy andembolic protection devices increased 68.7% to $2.9 million in the threemonths ended October 2, 2005 compared to the three months ended October 3,2004 largely due to the introduction of the SpideRX internationally and theintroduction of the X-Sizer in the United States in late 2004, partially offsetby sales declines in older generation products. Net sales in our procedural support and other product lines increased26.3% to $7.0 million in the three months ended October 2, 2005 comparedto $5.5 million in the three months ended October 3, 2004.  This increase is primarily attributable tothe increase in sales of our PTA balloons which were launched early in2005.  We expect our cardio peripheralnet sales to increase during the remainder of 2005 primarily as a result ofintroducing several new products during the year, especially in our stentfamily, and continued market penetration from our recently expanded salesforce.

 

*Net sales of neurovascularproducts.*    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 by geography.*    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 of goods 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 andadministrative expense.*    Sales, general andadministrative expense increased 27.8% to $30.7 million in the three monthsended October 2, 2005 compared to $24.0 million in the three months ended October 3,2004. This increase was due to a $5.6 million increase in selling expensesprimarily related to the increase in our U.S. direct sales force describedabove and an increase in expenses related to expanding our international salespresence, a $1.1 million increase in legal expenses in the cardioperipheral segment and a $500 thousand increase in general and administrativeexpenses, partially offset by a $500 thousand reduction in legal expenses inthe

 

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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 and development.*    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.

 

*Amortization of intangibleassets.*    Amortization of intangible assets increased 9.7% to$2.7 million in the three months ended October 2, 2005 compared to $2.4million in the three months ended October 3, 2004.  This increase was primarily a result ofadditional 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) loss on sale ordisposal of assets, net.*    We incurred a loss on sale ordisposal 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 from operations.*    Our loss from operations increased 79.9% to$21.9 million for the three months ended October 2, 2005 compared with$12.2 million 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 the thirdquarter 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.

 

*Minority interest in loss ofsubsidiary.*    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 tax benefit.*    Weincurred 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 of preferredmembership 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 into us immediatelyprior to our initial public offering. Accretion was discontinued upon conversion of the preferred units tocommon membership units on June 21, 2005.

 

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

 

*Net sales.*    Netsales increased 52.5% to $92.7 million in the nine months ended October 2,2005 compared to $60.8 million in the nine months ended October 3,2004, primarily as a result of new product introductions and the expansion ofour distribution system during 2004. Our U.S. direct sales force was increasedfrom 44 persons at the beginning of 2004 to 82 persons at the beginning of 2005with most of the growth occurring in the fourth quarter of 2004. The salesforce expansion was primarily to support new product introductions that beganin late 2004 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 of cardioperipheral products.*    Net sales of our cardioperipheral products increased 47.9% to $55.9 million in the nine monthsended October 2, 2005 compared to $37.8 million in the nine monthsended October 3, 2004. This sales growth was primarily the result of newproduct introductions and the expansion of our U.S. sales force in the fourthquarter of 2004 as described above, partially offset by sales declines in oldergeneration products. Key new product launches that contributed to the salesincrease for the nine months ended October 2, 2005 included the Protégéstents, Primus stents, PTA balloon catheters, SpideRX embolic protectionsystem, the X-Sizer thrombectomy catheter, the Diver C.E. aspiration catheterand ParaMount Mini stents.  Net sales inour stent product line increased 74.5% to $25.8 million in the nine monthsended October 2, 2005 compared to $14.8 million in the nine 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 2004, partially offset by sales declines in oldergeneration products. Net sales of our thrombectomy and embolic protectiondevices increased 65.6% to $9.4 million in the nine months ended October 2,2005 compared to the nine months ended October 3, 2004 largely due to theintroduction of the SpideRX internationally and the introduction of the X-Sizerin the United States in late 2004, partially offset by sales declines in oldergeneration products.  Net sales of ourprocedural support and other products increased 19.5% to $20.7 million in thenine months ended 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 of neurovascularproducts.*    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 by geography.*    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 in Japan.  The sales growth in our international marketswas primarily a result of new product introductions and increased penetration.

 

*Cost of goods 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 andadministrative expense.*    Sales, general andadministrative expense increased 31.8% to $94.8 million in the nine monthsended October 2, 2005 compared to $72.0 million in the nine monthsended October 3, 2004. This increase was due to a $17.6 millionincrease in selling expenses primarily related to the increase in the U.S.direct sales force described above and an increase in expenses related toexpanding our international sales presence, a $5.3 million increase in generaland administrative expenses, a $2.4 million increase in marketing anddistribution expenses and a $1.0 million increase in legal expenses in ourcardio peripheral segment, partially offset by $3.4 million reduction in legalexpenses in our neurovascular segment.

 

*Research and development.*    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.

 

*Amortization of intangibleassets.*    Amortization of intangible assets increased 6.2% to$7.9 million in the nine months ended October 2, 2005 compared to$7.4 million in the nine months ended October 3, 2004. This increasewas primarily a result of additional amortizable intangible assets related toVertical’s May 26, 2005 contribution to ev3 LLC of shares of MTI. Thiscontribution was accounted for under the purchase method of accounting basedupon the proportionate ownership contributed to ev3 LLC and resulted in anincrease in the amortizable intangible assets of approximately $3.4 million.

 

*(Gain) loss on sale ordisposal of assets, net.*    We incurred a loss on sale ordisposal 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.

 

*Acquired in-process researchand development.*    During the nine months ended October 2,2005, we incurred a charge of $868 thousand for acquired in-process researchand development 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 not incurcharges for acquired in-process research and development expense during thenine months ended October 3, 2004.

 

*Gain on sale of investments,net.*    Gain on 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 thenine months ended October 2, 2005, we received a $3.7 million milestonepayment related to the sale of our investment in Genyx Medical, Inc. andreceived a $900 thousand milestone payment relating to our 2002 sale of ourinvestment 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 from operations.*    Our loss from operations increased 29.6% to$80.2 million for the nine months ended October 2, 2005 compared with$61.9 million 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 months ended October 2, 2005 compared to$20.4 million for the nine months ended October 3, 2004.  Interest (income) expense, net decreased by$9.6 million due to several factors. During the first nine months of 2004, we recorded a $6.8 millioncharge related to beneficial conversion features arising from the minorityinterests’ participation in two financings of MTI during 2004 which did notre-occur during 2005.  Our outstandingdebt balance was converted into common stock in connection with our initialpublic offering in June 2005, which resulted in a $1.8 million decrease ininterest expense.   We generatedapproximately $1.0 million of interest income during the third quarter of 2005from investing the net proceeds of our initial public offering in June 2005.

 

*Minority interest in loss ofsubsidiary.*    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 tax benefit.*    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 of preferredmembership 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 and CapitalResources**

 

*Financing history.*    Sinceinception, we have generated significant operating losses. These operating losses,including cumulative non-cash charges for acquired in-process research anddevelopment of $127 million, have resulted in an accumulated deficit of $540.7million as of October 2, 2005. Historically, our liquidity needs and theliquidity needs of MTI have been met separately. In general, MTI has beenfunded through equity private placements and the issuance of promissory notes,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, cash equivalents andshort-term investments.*    As of October 2, 2005, wehad cash, cash equivalents and short-term investments of $106.8 million.

 

| **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 | ) |

 

*Contractual cash 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)          Representscommitments for minimum inventory purchases related to our distributionagreement with Invatec S.r.l. We do not have any other significant purchaseobligations for the delivery of goods or services or other commercialcommitments.

 

(2)          The amounts reflected in the table above for operatingleases represent future minimum lease payments under non-cancelable operatingleases primarily for certain office space, warehouse space, computers andvehicles. Portions of these payments are denominated in foreign currencies andwere 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 monthsended October 2, 2005 was $74.3 million, reflecting primarily the netlosses and increased working capital requirements during the period, partiallyoffset by non-cash charges for depreciation and amortization and non-cashinterest expense presented as accrued interest on notes payable. Our net lossalso reflected $4.6 million of gain recognized on the sale of investments, asdiscussed below.  The increases in accountsreceivable and inventories during the nine months ended October 2, 2005were related to increases in sales volume during the period.  We expect that operations will continue touse cash during the remainder of 2005.

 

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*Investingactivities.    *Cash used in investing activities during thenine months ended October 2, 2005 was $19.8 million primarily due tothe investment of $12.0 million in short-term investment-grade securities, thepurchase of $9.9 million of property and equipment and a $3.7 millionmilestone payment related to a previous acquisition.  The net use of cash from investing activitieswas reduced by the receipt of $3.7 million from the sale of certain assetsby Genyx Medical, Inc., in which MTI holds a minority interest, thereceipt of $2.1 million in a settlement of an acquisition dispute and thereceipt of a $900 thousand milestone payment related to our 2002 sale of ourinvestment in Enteric Medical Technologies, Inc. Historically, our capitalexpenditures have consisted of purchased manufacturing equipment, research andtesting equipment, computer systems and office furniture and equipment.  We continue to make investments in propertyand equipment and expect to incur an additional $6.0 million in capitalexpenditures during the balance of 2005.

 

*Financingactivities.    *Cash provided by financing activities was$168.8 million during the nine months ended October 2, 2005,consisting of $154.9 million of net proceeds received from the initial publicoffering of our common stock, inclusive of the underwriters’ exercise of theirover-allotment option on July 20, 2005, and proceeds of $49.1 million fromthe issuance of demand notes.  Thesereceipts were partially offset by the repayment of $36.5 million of accrued andunpaid interest on outstanding debt with a portion of the net proceeds from ourinitial public offering.

 

*Other liquidity information.*

 

On July 20, 2005, we sold 205,800 sharesof common stock pursuant to the over-allotment option granted to theunderwriters 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, MTI entered into alease 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, we and MTI finalizedthe terms of the unsecured term note and MTI executed it.  Under the Note, MTI may make draw downs fromtime 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 entire outstandingunpaid principal balance of the note and all accrued and unpaid interestthereon 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 such expirationdate may be extended.

 

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

 

The acquisition agreementsrelating to our purchase of MitraLife, Appriva Medical, Inc. and Dendron GmbHrequire us to make additional payments to the sellers of these businesses ifcertain milestones related to regulatory steps in the product commercializationprocess 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 September27, 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 achieving certainrevenue targets between 2003 and 2008. In 2003, the $4.0 million revenuetarget for sales of Dendron products during 2003 was met. Accordingly, anadditional payment to the former Dendron stockholders of $3.75 million wasmade 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.

 

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 and continuingacceptance of our products in the marketplace. We believe that the resourcesgenerated from our initial public offering are sufficient to meet our liquidityrequirements through the end of fiscal 2006; however, if we require additionalworking capital, but are not able to raise additional funds, we may be requiredto 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, asfurther 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 throughJuly 4, 2006 and will be reduced to the extent of proceeds, if any, thatbecome available from a third party lender, including amounts available underthe credit 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 financingtransaction will not be dilutive to current stockholders. If we requireadditional working capital, but are not able to raise additional funds, we maybe required to significantly 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 million of theamounts set aside in escrow in connection with Boston Scientific’s merger withEnteric Medical Technologies, Inc.  InMay 2005, MTI received $878 thousand of the remaining portion of escrowedamounts under the merger agreement.  MTIexpects to receive the remaining amount of approximately $850 thousand in May2006, provided that no claims are made by Boston Scientific against the amountsin 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 its lossfrom operations, increases in trade receivables, inventories and prepaid expenses,net of increases  in accounts payable andaccrued compensation, all of which reflect the general increase in the volumeof MTI’s operations, and a decrease in accrued liabilities that reflectsprimarily payments of, and reductions in, MTI’s estimates of amounts payablepursuant to the consolidation of MTI’s German facility into its Irvine,California operations in late 2004, and to reductions in MTI’s estimate ofamounts payable pursuant to a previously terminated distributor agreement.  We expect that MTI’s operations will continueto consume cash during a substantial portion of the remainder of 2005, andachieve a breakeven cash flow from operations in early 2006.

 

*Investingactivities. *Cash provided by investing activities duringthe nine months ended October 2, 2005 was $145 thousand, primarily resultingfrom the receipt of $3.7 million from the sale of assets of Genyx Medical, Inc,receipt of $878 thousand in connection with Boston Scientific’s merger withEnteric Medical Technologies, Inc., and the restoration to cash of certificatesof deposit, aggregating $880 thousand, that had been segregated from cashbalances during the period that such certificates of deposit served ascollateral for bank letters of credit which expired in 2005. Cash provided byinvesting activities during the nine months ended October 2, 2005 was offset bya $3.75 million payment to the former Dendron stockholders and the acquisitionof 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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*Other liquidityinformation.*

 

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 hasreceived a support letter from Warburg Pincus pursuant to which Warburg Pincushas agreed to provide additional funding of up to $5.0 million to MTI, ifneeded, to fund MTI’s operations. The Warburg Pincus commitment is effectivethrough July 4, 2006 and will be reduced to the extent of proceeds, ifany, that become available from a third party lender, including amountsavailable under the credit facility described above, or any amounts raised in athird party financing. We believe that MTI’s existing cash at October 2, 2005,anticipated net cash flows related to operations for the remainder of 2005 andfor 2006, and the proceeds under either the credit facility or the fundingcommitment of Warburg Pincus, will be sufficient to fund MTI’s operations forthe next twelve months. There is no assurance that any additional financingtransactions will be available on terms acceptable to MTI or us, or at all, orthat any financing transactions will not be dilutive to current MTIstockholders or our stockholders. There is no assurance that MTI will achievecash flow positive operations or that, if achieved, such cash flow positiveoperations 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.  The leasefor 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, ev3Endovascular, Inc. has provided MTI with a $1.0 million standby irrevocableletter of credit in favor of the landlord for the new facilities, to providethe MTI with additional financing to support the planned tenant improvements.

 

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

 

In connection with itsacquisition of Dendron, MTI may be required to make additional payments whichare contingent upon Dendron products achieving certain revenue targets between2003 and 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 inOctober 2002. While we believe that Dendron has made its tax filings inconformity with German tax regulations, we are unable to predict what, if any,areas of inquiry might be pursued by German tax authorities in connection withan audit in general, or specifically in connection with either MTI’sacquisition of Dendron or the subsequent closure of MTI’s German manufacturingfacility or whether, or to what extent, Dendron will be subject to additionalliability 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 BulletinNo. 101, *Revenue Recognition inFinancial Statements*, which requires that four basic criteria mustbe met before sales can be recognized: (1) persuasive evidence of anarrangement exists; (2) delivery has occurred or services have beenrendered; (3) the price is fixed or determinable; and(4) collectibility is reasonably assured. These criteria are met at thetime of shipment when risk of loss and title passes to the customer or distributor,unless a consignment arrangement exists. Sales from consignment arrangementsare recognized upon written acknowledgement that the product has been used bythe customer indicating that a sale is complete. Our terms of sale for regularsales are typically FOB shipping point, net 30 days. Regular sales includeorders from customers for replacement of customer stock, replenishment ofcustomer consignment product, orders for a scheduled case/surgery and stockingorders.

 

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 the financialcondition of customers were to deteriorate, resulting in impairment of theirability to make payments, an increase in the provision for doubtful accountsmay be required. We maintain a large customer base that mitigates the risk ofconcentration with one customer. However, if the overall condition of thehealth 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, 2005and 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 salesforecasts. Future product introductions and related inventories may requireadditional reserves based upon changes in market demand or introduction ofcompeting technologies. Increases in the reserve for excess and obsoleteinventory result in a corresponding expense to cost of goods sold. Our reservefor excess and obsolete inventory was $3.8 million and $3.7 millionat October 2, 2005 and December 31, 2004, respectively.

 

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***Valuation of Acquired In-Process Research and Development, Goodwill andOther 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 thousand relatedto the May 26, 2005 contribution to ev3 LLC by Vertical of certain shares ofMTI 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 and liabilities,which are included on our consolidated balance sheets. We must then assess thelikelihood that our deferred tax assets will be recovered from future taxableincome and, to the extent we believe that recovery is not likely, we mustestablish 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 innature. Historically, demand for our products has been the highest in ourfourth fiscal quarter. We traditionally experience lower sales volumes in ourthird fiscal quarter than throughout the rest of the year as a result of theEuropean holiday schedule during the summer months.

 

**Off-BalanceSheet Arrangements**

 

We do not have any off-balancesheet arrangements, as defined by the rules and regulations of the Securitiesand Exchange Commission, that have or are reasonably likely to have a materialeffect on our financial condition, changes in financial condition, revenues orexpenses, results of operations, liquidity, capital expenditures or capitalresources.  As a result, we are not materially exposed to any financing,liquidity, market or credit risk that could arise if we had engaged in thesearrangements.

 

**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 Form10-Q contains not only historical information, but also forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933 andSection 21E of the Securities Exchange Act of 1934 and are subject to the safeharbor created by those sections.  Inaddition, we or others on our behalf may make forward-looking statements fromtime to time in oral presentations, including telephone conferences and/or webcasts open to the public, in press releases or reports, on our Internet website or otherwise.  All statements otherthan statements of historical facts included in this report that addressactivities, events or developments that we expect, believe or anticipate willor may occur in the future are forward-looking statements including, inparticular, the statements about ev3’s plans (including MTI), objectives,strategies and prospects regarding, among other things, the financialcondition, results of operations and business of ev3 Inc. and itssubsidiaries.  We have identified some ofthese forward-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 other words 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.  Our expectationsreflected in our forward-looking statements can be affected by inaccurateassumptions we might make or by known or unknown risks and uncertainties,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 Form10-K, quarterly reports on Form 10-Q and current reports on Form 8-K we filewith 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 to liabilityor impede the completion of the transaction. In addition, even if we do complete the transaction, we may not be ableto achieve the anticipated efficiencies and cost 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 ourproducts that 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,clinical trials, 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 a competitiveadvantage.  Whether a product infringes apatent involves complex legal and factual issues, the determination of which isoften uncertain.  We face the risk ofclaims 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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In addition, new patentsobtained by our competitors could threaten a product’s continued life in themarket even after it has already been introduced.

 

***We are currently a party to a number of intellectual property claims,the resolution of which could have a material adverse effect on our businessand results of operations.***

 

We cannot assure you that wedo not infringe any patents or other proprietary rights held by third parties.In that regard, in March 2005, Medtronic, Inc. contacted us to express itsview that our Protégé stents infringe on one or more of its patents.  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 also received notice from an individual regarding ourPercutaneous Left Atrial Appendage Transcatheter Occlusion device, or PLAATO®,which is designed to reduce the risk of stroke by occluding the left atrialappendage, a small pocket attached to the heart’s left upper chamber that haslimited functional use and is the location of a majority of blood clots in theheart.  The individual claims that hebelieves 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.  In March 2005, we were servedwith a complaint by Boston Scientific Corporation and one of its affiliateswhich claims that some of our products, including our SpideRX EmbolicProtection Device, infringe on certain of Boston Scientific’s patents.  Boston Scientific is seeking monetary damagesfrom 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.

 

We may also be subject todisputes as to the ownership of patents that we may develop with othercompanies.  Such disputes could result inthe enjoining of sales of our products or our being required to paycommercially unreasonable licensing fees. If this occurs, our net sales or the cost of selling the infringingproduct, and therefore our results of operations, would be negatively affected.

 

MTI is involved in severalpatent disputes.  Prior to MTI’sacquisition of Dendron GmbH, Dendron became involved in litigation in Europeinvolving patents covering certain of its products, which litigation is stillactive.  Concurrent with its acquisitionof Dendron, MTI initiated a series of legal actions in the Netherlands and theUnited Kingdom with the primary purpose of asserting both invalidity andnon-infringement by it of certain patents held by others with respect todetachable coils and certain delivery systems. In addition, the patent holders against whom MTI initiated the actionsin the Netherlands and the United Kingdom have initiated legal actions againstMTI in the United States that allege infringement by MTI of certain patentsheld by them.  An adverse determinationin a judicial or administrative proceeding or failure to obtain licenses, ifnecessary, could prevent MTI from manufacturing and selling its products, whichwould in turn have 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.***

 

We have entered into anagreement with Invatec S.r.l., or Invatec, an Italian manufacturer ofendovascular medical devices which prior to our arrangement have not beenmarketed or sold under the Invatec brand in the United States, to distributeInvatec’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 in relianceon this agreement and have invested significantly in regulatory, intellectualproperty and clinical activities to support the introduction of Invatec’sproducts in the United States.  Oursuccess in marketing the Invatec products will depend on these new

 

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sales personnel becomingproficient in the product line, building physician relationships and executingsales orders.  If we are unable to marketInvatec’s products successfully or if our agreement with Invatec is terminated,our net sales and results of operations would suffer.  If we do not meet our performancerequirements under the agreement, the agreement may be terminated by Invatecand we may be obligated to make substantial payments to Invatec.  In addition, even if we market Invatec’sproducts successfully, if Invatec is unable to produce enough of its productsto 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 intellectual property rights do not adequatelyprotect our products, we may lose market share to our competitors and be unableto operate our business profitably.***

 

Our success dependssignificantly on our ability to protect our proprietary rights to thetechnologies used in our products.  Werely on patent protection, as well as a combination of copyright and trademarklaws and nondisclosure, confidentiality and other contractual arrangements toprotect our proprietary technology. However, these legal means afford only limited protection and may notadequately protect our rights or permit us to gain or keep any competitiveadvantage.  In addition, we cannot beassured that any of our pending patent applications will result in the issuanceof a patent to us.  The United StatesPatent and Trademark Office, or PTO, may deny or require significant narrowingof claims in our pending patent applications, and patents issued as a result ofthe pending patent applications, if any, may not provide us with significantcommercial protection 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 be ableto design around our patents.  We alsorely 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 beenforceable or may not provide meaningful protection for our proprietaryinformation in the event of unauthorized use or disclosure or other breaches ofthe agreements or in the event that our competitors discover or independentlydevelop similar or identical 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 offoreign countries may not protect our intellectual property rights to the sameextent as the laws of the United States. For example, foreign countries generally do not allow patents to covermethods for performing surgical procedures. If we cannot adequately protect our intellectual property rights inthese foreign countries, our competitors may be able to compete more directlywith us, which could adversely affect our competitive position and ourbusiness.

 

We also hold licenses fromthird parties that are necessary to utilize certain technologies used in thedesign 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 single locations.  Any disruption in these manufacturingfacilities or any patent infringement claims with respect to our manufacturingprocess could adversely affect our business and results of operations.***

 

We have relied to dateprincipally on our manufacturing facility in Plymouth, Minnesota and our formerfacility in New Brighton, Minnesota, and MTI’s facility in Irvine,California.  We closed our New Brighton,Minnesota manufacturing facility in July 2005 and moved its operations to ourPlymouth facility.  In addition, in October2005,

 

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MTI entered into a lease fornew space in Irvine, California to which MTI will relocate its existing Irvineoperations, including its manufacturing facility. Our Plymouth and Irvinefacilities and the manufacturing equipment we use to produce our products wouldbe difficult to replace and could require substantial lead-time to repair orreplace.  Our facilities may be affectedby natural or man-made disasters.  In theevent one of our two facilities was affected by a disaster, we would be forcedto rely on third-party manufacturers if we could not shift production to ourother manufacturing facility.  In thecase of a device with a pre-market approval application we may be required toobtain prior U.S. Food and Drug Administration or notified body approval of analternate manufacturing facility, which could delay or prevent our marketing ofthe affected product until such approval is obtained.  Although we believe we possess adequateinsurance for damage to our property and the disruption of our business fromcasualties, such insurance may not be sufficient to cover all of our potentiallosses and may not continue to be available to us on acceptable terms, or atall.  It is also possible that one of ourcompetitors could claim that our manufacturing process violates an existingpatent.  If we were unsuccessful indefending such a claim, we may be forced to stop production at one or both ofour manufacturing 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 chief executive officer or other keypersonnel, we may not be able to manage our operations and meet our strategicobjectives.***

 

Our future success depends, inlarge part, on the continued service of James M. Corbett, our president andchief executive officer. Mr. Corbett’s continuation with us is integral to our futuresuccess, based on his significant expertise and knowledge of our business andproducts.  Although we have key personinsurance with respect to Mr. Corbett, any loss or interruption of theservices of Mr. Corbett could significantly reduce our ability toeffectively manage our operations and implement our strategy.  Also, we depend on the continued service ofkey managerial, scientific, sales and technical personnel, as well as ourability to continue to attract and retain additional highly qualifiedpersonnel, especially experienced medical device sales personnel.  We compete for such personnel with othercompanies, 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 at risk of interruptions in theavailability of our products, which could reduce our net sales and adverselyaffect our results of operations. In addition, increases in prices for rawmaterial and components used in our products could adversely affect our resultsof operations.***

 

We rely on a limited number ofsuppliers for the raw materials and components used in our products.  Our raw materials and components aregenerally acquired through purchase orders placed in the ordinary course ofbusiness, and we do not have any guaranteed or contractual supply arrangementswith 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.  Our dependenceon third-party suppliers involves several risks, including limited control overpricing, availability, quality and delivery schedules, as well as manufacturingyields and costs.  Suppliers of rawmaterials and components may decide, or be required, for reasons beyond ourcontrol to cease supplying raw materials and components to us. Shortages of rawmaterials, quality control problems, production capacity constraints or delaysby our contract manufacturers could negatively affect our ability to meet ourproduction obligations and result in increased prices for affected parts.  Any such shortage, constraint or delay mayresult in delays in shipments of our products or components, which couldadversely affect our net sales and results of operations.

 

In addition, the FDA andforeign regulations may require additional testing of any raw materials orcomponents from new suppliers prior to our use of these materials orcomponents.  In the case of a device witha pre-market approval application, we may be required to obtain prior FDAapproval of a new supplier, which could delay or

 

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prevent our access or use ofsuch raw materials or components or our marketing of affected products untilsuch approval is granted.  In the case ofa device with clearance under Section 510(k) of the Federal Food, Drug andCosmetic Act, which we refer to as a 510(k), we may be required to submit a new510(k) if a change in a raw material or component supplier results in a change ina material or component supplied that is not within the 510(k) cleared devicespecifications.  If we need to establishadditional or replacement suppliers for some of these components, our access tothe components 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 for distributionand sale.

 

***Existing or future acquisitions of businesses could negatively affectour results of operations if we fail to integrate the acquired businessessuccessfully into our existing operations or if we discover previouslyundisclosed liabilities.***

 

In order to build our coretechnology platform, we have acquired several businesses since our inceptionand we may acquire additional businesses in the future.  Our ability to grow through acquisitionsdepends upon our ability to identify, negotiate, complete and integratesuitable 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 and attentionfrom 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.

 

In addition, an acquisitioncould materially impair our operating results and liquidity by causing us toincur debt or reallocate amounts of capital from other operating initiatives orrequiring us to amortize acquisition expenses and acquired assets or incurnon-recurring charges as a result of incorrect estimates made in the accountingfor acquisitions.  We may also discoverdeficiencies in internal controls, data adequacy and integrity, productquality, regulatory compliance and product liabilities which we did not uncoverprior to our acquisition of such businesses, which could result in us becomingsubject to penalties or other liabilities. Any difficulties in the integration of acquired businesses or unexpectedpenalties or liabilities in connection with such businesses could have amaterial adverse effect on our results of operations and financial condition.These risks could be heightened if we complete several acquisitions within arelatively short period of time.

 

***We or MTI may require additional capital in the future, which may notbe available or may be available only on unfavorable terms.***

 

Our and MTI’s capitalrequirements depend on many factors, including the amount of expenditures onintellectual property and technologies, the number of clinical trials which weconduct, 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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adequately complement ourexisting product portfolio.  We and MTIhave each historically relied on financing from Warburg Pincus and Vertical,but there can be no assurance that Warburg Pincus, Vertical or other investorswill provide such financing in the future. Any equity or debt financing, if available at all, may be on terms thatare not favorable to us. Equity financings could result in dilution to ourstockholders, and the securities issued in future financings may have rights,preferences and privileges that are senior to those of our common stock.  If our need for capital arises because ofsignificant losses, the occurrence of these losses may make it more difficultfor us to raise the necessary capital. In addition, because MTI is not our wholly owned subsidiary, ourcreditors are limited in their ability to satisfy their claims against us byseeking recourse to MTI’s assets, which could impair our ability to obtainfinancing.

 

***We may experience conflicts of interest with MTI with respect tobusiness opportunities and other matters.***

 

Our neurovascular operationsare comprised of our interest in and relationships with MTI.  MTI is a public company whose stock is tradedon the NASDAQ National Market System.  Weown 70.2% of the outstanding shares of common stock of MTI based on the numberof shares outstanding as of October 2, 2005. In addition, our board ofdirectors is comprised of seven persons, four of whom are also members of theboard of directors of MTI.  Thesedirectors are James M. Corbett, Richard B. Emmitt, Dale A. Spencer andElizabeth H. Weatherman.  Ourrelationships with MTI are significant elements of our business.  Under a number of agreements that we haveentered 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.

 

Although MTI is our controlledsubsidiary, it is not our wholly owned subsidiary, and conflicts of interestmay arise with respect to transactions involving business dealings between usand MTI, potential acquisitions of businesses or products, development ofproducts and other matters with respect to which our best interests and thebest interests of our stockholders may conflict with the best interests of thepublic stockholders of MTI.  Because aportion of MTI is owned by minority stockholders, we cannot treat MTI as wewould a wholly owned subsidiary.  Withrespect to our transactions with MTI, although we have formed a specialcommittee of our board of directors that consists of all of the non-MTIdirectors to alleviate conflict of interest concerns, we cannot assure you thatwe will negotiate terms that are as favorable to us as if such transactionswere with an unaffiliated third party or that any conflicts of interest will beresolved in our favor.  Further, thefiduciary duties of the members of MTI’s board of directors may result inactions that are not in our stockholders’ best interests.  Because of its importance to our business, wemay elect to fund MTI’s operations in circumstances in which we undertake alarge amount of risk but which will benefit all of MTI’s stockholders,including its public stockholders, and from which we may only receive theeconomic benefit in proportion to our ownership interest in MTI.  In addition, we are required to share anydividends that are declared by MTI on its common stock or other distributionsof its assets with MTI’s public stockholders on a pro rata basis, which willrestrict our ability to access any funds and assets held by MTI.

 

***The value of our interest in MTI may decline or our interest in MTIcould be diluted.***

 

Any decline in the marketprice of MTI’s common stock on the NASDAQ National Market System will cause thevalue of the shares of MTI’s common stock which we own to decline.  MTI has not been profitable since itsfounding and may continue to incur significant losses and negative cash flowsin the future, which could negatively impact the market price of its commonstock 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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decline to exercise thisright, Warburg Pincus or Vertical  mayalso elect to provide financing directly to MTI in the future. In the eventthat MTI raises additional capital through equity offerings to Warburg Pincus,Vertical  or other investors, ourownership interest in MTI could be diluted.

 

***Our sales would decline if our customers or their patients cannotobtain third party reimbursement for their purchases of our products.***

 

Sales of our products dependin part on the reimbursement by governmental and private health care payors toour physician customers or their patients for the purchase and use of ourproducts.  In the United States, healthcare providers that purchase our products generally rely on third-party payors,principally federal Medicare, state Medicaid and private health insuranceplans, to pay for all or a portion of the cost of endovascular procedures.  Reimbursement systems in internationalmarkets vary significantly by country, and by region within some countries, andreimbursement approvals must be obtained on a country-by-country basis and cantake up to 18 months or longer. Many international markets have government-managed health care systemsthat govern reimbursement for new devices and procedures.  In most markets, there are private insurancesystems as well as government-managed systems. Additionally, some foreign reimbursement systems provide for limitedpayments in a given period and therefore result in extended payment periods.  Any delays in obtaining, or an inability toobtain, reimbursement approvals could have a material adverse effect on ourbusiness.  In addition, if thereimbursement policies of domestic or foreign governmental or private healthcare payors were to change, our customers would likely change their purchasingpatterns and/or the frequency of their purchases of the affected products.Additionally, payors continue to review their coverage policies carefully forexisting and new therapies and can, without notice, deny coverage fortreatments that include the use of our products.  Our business would be negatively impacted tothe extent any such changes reduce reimbursement for our products.

 

In addition, some health careproviders in the United States have adopted or are considering a managed caresystem in which the providers contract to provide comprehensive health care fora fixed cost per person.  Health careproviders may attempt to control costs by authorizing fewer elective surgicalprocedures or by requiring the use of the least expensive devices possible,which could adversely affect the demand for our products or the price at whichwe can sell our products.

 

We also sell a number of ourproducts to physician customers who may elect to use these products in waysthat are not within the scope of the approval or clearance given by the FDA,often referred to as “off-label” use.  Inthe event that governmental or private health care payors limit reimbursementfor products used off-label, sales of our products and our business would bematerially adversely affected.

 

***Our products and facilities are subject to extensive regulation withwhich compliance is costly and which exposes us to penalties fornon-compliance.  We may not be able toobtain required regulatory approvals for our products in a cost-effectivemanner or at all, which could adversely affect our business and results ofoperations.***

 

The production and marketingof our products and our ongoing research and development, preclinical testingand clinical trial activities are subject to extensive regulation and review bynumerous governmental authorities both in the United States and abroad. U.S.and foreign regulations applicable to medical devices are wide-ranging andgovern, among other things, the testing, marketing and pre-market review of newmedical devices, in addition to regulating manufacturing practices, reporting,advertising, exporting, labeling and record keeping procedures.  We are required to obtain FDA approval orclearance before we can market our products in the United States and certainforeign countries.  The regulatoryprocess requires significant time, effort and expenditures to bring ourproducts to market, and we cannot assure that any of our products will beapproved for sale.  Any failure to obtainregulatory approvals or clearances could prevent us from successfully marketingour products, which could adversely affect our business and results ofoperations.  Our failure to comply withapplicable regulatory 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.

 

If any or all of the foregoingwere to occur, we may not be able to meet the demands of our customers and ourcustomers may cancel orders or purchase products from our competitors, whichcould adversely affect our business and results of operations.

 

Even if regulatory approval orclearance of a product is granted, the approval or clearance could limit theuses for which the product may be labeled and promoted, which may limit themarket for our products.  Further, for amarketed product, its manufacturer and manufacturing facilities are subject toperiodic reviews and inspections 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.

 

We are currently conductingclinical studies of some of our products under an investigational deviceexemption.  Clinical studies must beconducted in compliance with regulations of the FDA and those of regulatoryagencies in other countries in which we conduct clinical studies.  The data collected from these clinicalinvestigations will ultimately be used to support market clearance for theseproducts.  There is no assurance thatregulatory bodies will accept the data from these clinical studies or that theywill ultimately allow market clearance for these products.

 

When required, with respect tothe products we market in the United States we have obtained pre-marketnotification clearance under Section 510(k), but we do not believe certainmodifications we have made to our products require us to submit new 510(k)notifications.  However, if the FDAdisagrees with us and requires us to submit a new 510(k) notification formodifications to our existing products, we may be subject to enforcementactions by the FDA and be required to stop marketing the products while the FDAreviews the 510(k) notification.  If theFDA requires us to go through a lengthier, more rigorous examination than wehad expected, our product introductions or modifications could be delayed orcanceled, which could cause our sales to decline.  In addition, the FDA may determine thatfuture products will require the more costly, lengthy and uncertain pre-marketapproval application process. Products that are approved through a pre-marketapproval application generally need FDA approval before they can bemodified.  If we fail to submit changesto products developed under investigational device exemptions or pre-marketapproval applications in a timely or adequate manner, we may become subject toregulatory actions.

 

Because we are subject toextensive regulation in the countries in which we operate, we are subject tothe risk that regulations could change in a way that would expose us toadditional costs, penalties or liabilities. For example, in the United States we sell a number of our products tophysicians who may elect to use these products in ways that are not within thescope of the approval or clearance given by the FDA or for other thanFDA-approved indications, often referred to as “off-label” use.  There are laws and regulations prohibitingthe promotion of products for such off-label use which restrict our ability tomarket 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 not followthe policies, or that regulations would change in a way that may hinder ourability 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.

 

If additional regulatory requirementsare implemented in the foreign countries in which we sell our products, thecost of developing or selling our products may increase.  For example, in Japan, new regulations becameeffective

 

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on April 1, 2005 whichincrease the regulatory and quality assurance requirements for both ourmanufacturing facilities and our offices located in Japan in order to obtainand maintain regulatory approval to market our products there.  We expect that these new regulations willresult in higher costs and delays in securing approval to market our productsin Japan. In addition, we depend on our distributors outside the United Statesin seeking regulatory approval to market our devices in other countries and we aretherefore dependent on persons outside of our direct control to secure suchapprovals.  For example, we are highlydependent on distributors in emerging markets such as China and Brazil forregulatory submissions and approvals and do not have direct access to healthcare agencies in those markets to ensure timely regulatory approvals or promptresolution of regulatory or compliance matters. If our distributors fail to obtain the required approvals or do not doso in a timely manner, our net sales from our international operations and ourresults of operations may be adversely affected.

 

In addition, our business,properties and products are subject to foreign, federal, state and local lawsand regulations relating to the protection of the environment, naturalresources and worker health and safety and the use, management, storage, anddisposal of hazardous substances, wastes, and other regulated materials.Because we own and operate real property, various environmental laws also mayimpose liability on us for the costs of cleaning up and responding to hazardoussubstances that may have been released on our property, including releasesunknown to us.  These environmental lawsand regulations also could require us to pay for environmental remediation andresponse costs at third-party locations where we disposed of or recycledhazardous substances.  The costs ofcomplying with these various environmental requirements, as they now exist ormay be altered in the future, could adversely affect our financial conditionand results of operations.

 

***A number of our products are in clinical trials.  If these trials are unsuccessful, or if theFDA or other regulatory agencies do not accept the results of such trials,these products may not successfully come to market and our business prospectsmay suffer.***

 

Several of our products are inthe early stages of development.  Some ofour products only recently emerged from clinical trials and others have not yetreached the clinical trial stage.  Ourcurrently ongoing clinical trials include the CREATE trial designed to evaluatethe use of our SpideRX Embolic Protection Devices and our ProtégéSelf-Expanding Stent System in carotid artery stenting procedures in patientswho are high risk candidates for carotid endarterectomy.  We cannot assure you that we will besuccessful in reaching the endpoints in these trials or, if we do, that the FDAor other regulatory agencies will accept the results and approve the devicesfor sale.  Further, we continuallyevaluate the potential financial benefits and costs of our clinical trials andthe products being evaluated in them.  Ifwe determine that the costs associated with attaining regulatory approval of aproduct exceed the potential financial benefits of that product or if theprojected development timeline is inconsistent with our investment horizon, wemay choose to stop a clinical trial and/or the development of a product.  For example, in September 2005, we decided todiscontinue the development and commercialization of our PLAATO device, whichis designed to reduce the risk of stroke by occluding the left atrial appendagein the heart.  Although we recently hadobtained conditional approval from the FDA for an investigational deviceexemption, or IDE, clinical trial for our 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.

 

Our ability to market ourproducts in the United States will depend upon a number of factors, includingour ability to demonstrate the safety and efficacy of our products with validclinical data.  Our ability to market ourproducts outside of the United States is also subject to regulatory approval, includingour ability to demonstrate the safety of our products in the clinicalsetting.  Our products may not be foundto be safe and, where required, effective in clinical trials and may notultimately be approved for marketing by U.S. or foreign regulatoryauthorities.  Our failure to develop safeand effective products that are approved for sale on a timely basis would havea negative impact on our net sales.  Inparticular, if we do not reach the endpoints or obtain FDA approval withrespect to our products, our future growth may be significantly hampered. Inaddition, some of the products for which we are currently conducting trials arealready approved for sale outside of the United States.  As a result, while our trials are ongoing,unfavorable data may arise in connection with usage of our products outside theUnited States which could adversely impact the approval of such products in theUnited States.  Conversely, unfavorabledata from clinical trials in the United States may adversely impact sales ofour products outside of the United States.

 

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***The risks inherent in operating internationally and the risks ofselling and shipping our products and of purchasing our components and productsinternationally may adversely impact our net sales, results of operations andfinancial condition.***

 

We derive a significantportion of our net sales from operations in international markets.  For the nine months ended October 2, 2005 andOctober 3, 2004, 47.0% and 49.2% of our net sales, respectively, were derivedfrom our international operations.  Ourinternational distribution system consists of eight direct sales offices andapproximately 50 stocking distribution partners. In addition, we purchase somecomponents 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.

 

In addition, most of thecountries in which we sell our products are, to some degree, subject topolitical, economic and/or social instability. Our international sales operations expose us and our representatives,agents and distributors to risks inherent in operating in foreignjurisdictions.  These risks include:

 

•                                          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.

 

We cannot assure you that oneor more of the factors will not harm our business.  Any material decrease in our internationalsales would adversely impact our net sales, results of operations and financialcondition.  Our international sales arepredominately in Europe.  In Europe,health care regulation and reimbursement for medical devices vary significantlyfrom country to country.  This changingenvironment could adversely affect our ability to sell our products in someEuropean countries.

 

***Fluctuations in foreign currency exchange rates could result indeclines in our reported net sales and earnings.***

 

Because the majority of ourinternational sales are denominated in local currencies and not in U.S.dollars, our reported net sales and earnings are subject to fluctuations inforeign exchange rates.  Ourinternational net sales were favorably affected by the impact of foreign currencyfluctuations totaling $914 thousand in the nine months ended October 2, 2005and $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 large milestone payments that are notcurrently reflected in our financial statements in certain circumstances, whichwould negatively impact our cash flows from operations.***

 

Pursuant to the acquisitionagreements relating to our purchase of MitraLife and Appriva Medical, Inc.in January 2002 and August 2002, respectively, we agreed to makecertain additional payments to the sellers of these businesses in the eventthat 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.

 

On September 29, 2004, wesold substantially all of the assets constituting the MitraLife business toEdwards Lifesciences and we are no longer pursuing commercialization of theproduct line acquired in the MitraLife transaction.  As of the date that we sold these assets toEdwards Lifesciences, none of the milestones set forth in our agreement withthe sellers of MitraLife had been met. We have determined that we have no current obligations in respect ofthese milestone payments, and we do not believe that it is likely that we willhave obligations with respect to these milestones in the future.  Although we do not believe it is likely thatthese milestone payment obligations will become due in the future, it ispossible that the former stockholders of MitraLife could disagree and make aclaim for such payments.  Any suchdispute could be costly, result in payments in such amounts being made and divertour management’s time and attention away from our business.

 

The Appriva acquisitionagreement contains four milestones to which payments relate.  The firstmilestone was required by its terms to be achieved by January 1, 2005 inorder to trigger a payment equal to $50 million.  We have determinedthat the first milestone was not achieved by January 1, 2005 and that thefirst milestone is not payable.

 

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On May 20, 2005, MichaelLesh,  as an individual seller of Appriva stock and purporting torepresent certain other sellers of Appriva  stock, filed acomplaint in the Superior Court of the State of Delaware with individuallyspecified damages aggregating $70 million and other unspecified damagesfor several allegations, including that we, along with otherdefendants,  breached the acquisition agreement and an implied covenant ofgood faith and fair dealing by willfully failing to take the steps necessary tomeet the first milestone under the agreement, and thereby also failing tomeet certain other milestones, and further that one milestone was actuallymet.   The complaint also alleges fraud, negligent misrepresentationand violation of state securities laws in connection with the negotiation ofthe acquisition agreement.  We believe these allegations are without meritand intend to vigorously defend this action.  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 milestone payments should have been made. We believetheir assertions are without merit. On September 27, 2005, we announced ourdecision to discontinue the development and commercialization of our PLAATOdevice, which is the technology we acquired in the Appriva transaction.  While we do not believe that it is likelythat we will have obligations with respect to the first or other milestones, asdiscussed above, it is possible that the former sellers of Appriva stock coulddisagree and make a claim for such payments. The defense and resolution of the currently outstanding litigation filedby Lesh regarding the first milestone payment, the failure to reach agreement withthe new claimants on a resolution of our differences, or any similar dispute orother future litigation regarding the Appriva transaction milestone paymentscould be costly and negatively impact our cash flow from operations, as well asdivert our management’s time and attention away from our business.

 

***We rely on our independent sales distributors and sales associates tomarket and sell our products outside of the United States, Canada, Europe andJapan.***

 

Sales of our products inlocations outside of the United States, Canada, Europe and Japan represented12% and 15% of our net sales in the nine months ended October 2, 2005 andOctober 3, 2004, respectively.  Oursuccess outside of the United States, Canada, Europe and Japan depends largelyupon marketing arrangements with independent sales distributors and salesassociates, in particular their sales and service expertise and relationshipswith the customers in the marketplace. Independent distributors and sales associates may terminate theirrelationship with us, or devote insufficient sales efforts to ourproducts.  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 our operations.  We have experienced turnover with some of ourindependent distributors in the past that has adversely affected our short-termfinancial results while we transitioned to new independent distributors.  Similar occurrences could happen in the future.

 

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

 

In order for us to sell ourproducts, physicians must recommend and endorse them.  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. Federal Anti-Kickback Statute andsimilar state laws, we could be subject to criminal and civil penalties andexclusion from the Medicare and Medicaid programs, which could have a materialadverse effect on our business and results of operations.***

 

A provision of the SocialSecurity Act, commonly referred to as the Federal Anti-Kickback Statute,prohibits the offer, payment, solicitation or receipt of any form ofremuneration in return for referring, ordering, leasing, purchasing or arrangingfor or recommending the ordering, purchasing or leasing of items or servicespayable by

 

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Medicare, Medicaid or anyother Federal health care program.  TheFederal Anti-Kickback Statute is very broad in scope and many of its provisionshave not been uniformly or definitively interpreted by existing case law orregulations.  In addition, most of thestates in which our products are sold have adopted laws similar to the FederalAnti-Kickback Statute, and some of these laws are even broader than the FederalAnti-Kickback Statute in that their prohibitions are not limited to items orservices paid for by a Federal health care program but, instead, applyregardless of the source of payment. Violations of the Federal Anti-Kickback Statute may result insubstantial civil or criminal penalties and exclusion from participation inFederal health care programs.

 

All of our financialrelationships with health care providers and others who provide products or servicesto Federal health care program beneficiaries are potentially governed by theFederal 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 assumptions about the market for ourproducts, which, if incorrect, would adversely affect our business prospectsand profitability.***

 

We are focused on the marketfor endovascular devices used to treat vascular diseases and disorders.  We believe that the aging of the generalpopulation and increasingly inactive lifestyles will continue and that thesetrends will increase the need for our products. However, the projected demandfor our products could materially differ from actual demand if our assumptionsregarding these trends and acceptance of our products by the medical communityprove to be incorrect or do not materialize or if drug therapies gain morewidespread acceptance as a viable alternative treatment, which in each casewould adversely affect our business prospects and profitability.

 

***If MTI experiences a delay in the proposed relocation of its existingmanufacturing facility, the production of our neurovascular products may bedelayed.***

 

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.  MTIexpects to occupy the new facilities and vacate its existing facilities inIrvine in April 2006.  MTI’s new facilities, which include expandedmanufacturing capacity compared to its current facilities, will need to bequalified by regulatory agencies, including the FDA, prior to MTI being able tomanufacture products.  If MTI is not able to complete its relocation orregulatory qualification of its new facility in a timely manner, the productionof our neurovascular products may be delayed and our net sales and businesscould be materially adversely affected.

 

***Our business, net sales and results of operations may suffer if we donot pass the required regulatory inspections for our new locations formanufacturing peripheral stents and our neurovascular products.***

 

We closed our New Brighton,Minnesota manufacturing facility in July 2005 and are currently in the processof integrating our manufacturing operations formerly located in New Brighton,Minnesota, where we manufactured our peripheral stent product line, with ourmanufacturing operations in Plymouth, Minnesota.  In addition, MTI intends to relocate itsexisting Irvine, California operations, including its manufacturing facilityfor our neurovascular products, to the new space it has leased in Irvine.  We will be required to pass regulatoryinspections of the FDA**,** andpossibly other regulatory agencies of countries in which we sell our products,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 a large portion of our netsales. Our net sales and business prospects would be adversely affected ifsales of this product were to decline.***

 

We are dependent on ourProtégé GPS family of stents, which generated more than 10% of our net sales infiscal 2004 and more than 15% of our net sales in the nine months ended October2, 2005.  If our Protégé GPS stents wereto no longer be available for sale in any key market because of regulatory,intellectual property or any other reason, our net sales from these productsand from products that typically constitute ancillary purchases wouldsignificantly decline.  A significantdecline in our net sales could also negatively impact our product developmentactivities and therefore our business prospects.

 

In March 2005,Medtronic, Inc. contacted us to express its view that our Protégé stentsinfringe 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 claims that could have an adverseeffect on our business and results of operations.***

 

The manufacture and sale ofmedical devices exposes us to significant risk of product liability claims,some of which may have a negative impact on our business.  Our existing products were developedrelatively recently and defects or risks that we have not yet identified maygive rise to product liability claims. In addition, we have recently initiateda new quality control system and a new manufacturing model which has not beenin effect long enough for us to have the confidence that any errors or mistakesin implementation have been corrected. Our existing product liability insurance coverage may be inadequate toprotect us from any liabilities we may incur or we may not be able to maintainadequate product liability insurance at acceptable rates.  If a product liability claim or series ofclaims is brought against us for uninsured liabilities or in excess of ourinsurance coverage and it is ultimately determined that we are liable, ourbusiness could suffer.  Additionally, wecould experience a material design or manufacturing failure in our products, aquality system failure, other safety issues or heightened regulatory scrutinythat would warrant a recall of some of our products.  A recall of some of our products could alsoresult in increased product liability claims. Further, while we train our physician customers on the proper usage ofour products, we cannot ensure that they will implement our instructionsaccurately.  If our products are usedincorrectly by our customers, injury may result and this could give rise toproduct liability claims against us.  Anylosses that we may suffer from any liability claims, and the effect that anyproduct liability litigation may have upon the reputation and marketability ofour products, may divert management’s attention from other matters and may havea negative impact on our business and our results of operations.

 

***Our net sales could decline significantly if drug-eluting stents becomea dominant therapy in the peripheral vascular stent market and we are not ableto develop or acquire a drug-eluting stent to market and sell.***

 

The peripheral vascular marketis currently comprised exclusively of bare metal, or non drug-eluting,stents.  However, there are clinicalsituations in the periphery in which a drug-eluting stent may demonstrateclinical superiority over bare metal stents. To the extent that our peripheral stent customers seek stents with drugcoatings and we do not market and sell a drug-eluting peripheral stent or onethat achieves market acceptance, we may not be able to compete as effectivelywith those of our competitors that are able to develop and sell a drug-elutingstent, and our peripheral stent sales could decline.  If our peripheral stent sales were todecline, we could experience a significant decline in sales of some of ourother products which are routinely purchased in conjunction with stentpurchases.

 

***If we are unable to continue to develop and market new products andtechnologies, we may experience a decrease in demand for our products or ourproducts could become obsolete, and our business would suffer.***

 

We are continually engaged inproduct development and improvement programs, and new products represent asignificant component of our growth rate. We may not be able to compete effectively with our competitors unless wecan keep up with existing or new products and technologies in the endovasculardevice market. If we do not continue to introduce new products andtechnologies, or if those products and technologies are not accepted, we maynot 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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still undergoing clinicaltrials.  This could reduce the potentialdemand for our products and negatively impact our business prospects.Additionally, our competitors’ new products and technologies may beat ourproducts to market, may be more effective or less expensive than our productsor render our products obsolete.

 

***The marketing of our products requires a significant amount of time andexpense and we may not have the resources to successfully market our products,which would adversely affect our business and results of operations.***

 

The marketing of our productsrequires a significant amount of time and expense in order to identify thephysicians who may use our products, invest in training and education, andemploy a sales force that is large enough to interact with the targetedphysicians.  In addition, the marketingof our products requires interaction with many subspecialists who are movinginto new practice areas and may require more training and education from ourpersonnel than would be required with physicians who are not expanding theirpractice areas.  We may not have adequateresources to market our products successfully against larger competitors whichhave more resources than we do. If we cannot market our products successfully,our business and results of operations would be adversely affected.

 

***We face competition from other companies, many of which havesubstantially greater resources than we do and may be able to develop moreeffective products or offer their products at lower prices than we can, whichcould adversely impact our business, net sales and results of operations.  Consolidation in the medical technologyindustry would exacerbate these risks.***

 

The markets in which wecompete are highly competitive, subject to change and significantly affected bynew product introductions and other activities of industry participants.  The markets for our products are alsodominated by a small number of large companies, and we are a much smaller companyrelative to our primary competitors.  Ourproducts compete with other medical devices, including Invatec manufacturedproducts sold in the United States under other brand names, surgical proceduresand pharmaceutical products.  A number ofthe companies in the medical technology industry, including manufacturers ofperipheral vascular, cardiovascular and neurovascular products, havesubstantially greater capital resources, larger customer bases, broader productlines, larger sales forces, greater marketing and management resources, largerresearch and development staffs and larger facilities than ours and haveestablished reputations with our target customers, as well as worldwidedistribution channels that are more effective than ours. In addition, the industryhas recently experienced some consolidation. Consolidation could make the competitive environment more difficult forsmaller companies.  Because of the sizeof the vascular disease market opportunity, competitors and potentialcompetitors have historically dedicated and will continue to dedicatesignificant resources to aggressively promote their products. New productdevelopments that could compete with us more effectively are likely because thevascular disease market is characterized by extensive research efforts andtechnological progress.  Competitors maydevelop technologies and products that are safer, more effective, easier touse, less expensive or more readily accepted than ours.  Their products could make our technology andproducts obsolete or noncompetitive.  Ourcompetitors may also be able to achieve more efficient manufacturing anddistribution operations than we can and may offer lower prices than we couldoffer profitably.  We expect that as ourproducts mature, we will be able to produce our products in a more costeffective manner and therefore be able to compete more effectively, but it ispossible that we may not achieve such cost reductions.  Any of these competitive factors couldadversely impact our business, net sales and results of operations.

 

We also compete with othermanufacturers of medical devices for clinical sites to conduct humantrials.  If we are not able to locateclinical sites on a timely or cost-effective basis, this could impede ourability to conduct trials of our products and, therefore, our ability to obtainrequired regulatory clearance or approval.

 

***We rely on our management information systems for inventory management,distribution and other functions and to maintain our research and developmentand clinical data.  If our informationsystems fail to adequately perform these functions or if we experience aninterruption in their operation, our business and results of operations couldbe adversely affected.***

 

The efficient operation of ourbusiness is dependent on our management information systems.  We rely on our management information systemsto effectively manage accounting and financial functions; manage order entry,order fulfillment and inventory replenishment processes; and to maintain ourresearch 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.

 

Any such interruption couldadversely affect our business and results of operations.

 

***If MTI fails to timely report its financial results or produce itsfinancial statements, we may not be able to timely report our financial resultsor comply with Securities and Exchange Commission reporting and certificationrequirements, and our stock price may decline.***

 

As the owner of a controllinginterest in MTI, we consolidate the financial results of MTI in ourconsolidated financial statements.  MTIaccounted for a material portion of our net sales and gross profit in each of thenine months ended October 2, 2005 and October 3, 2004.  As a result, our ability to report ourfinancial results, produce our consolidated financial statements and filerequired reports with the Securities and Exchange Commission, or the SEC, in atimely manner will require MTI to provide us with its financial results andfinancial statements in a timely manner. If MTI fails to timely produce its financial results and financialstatements, we may not be able to report our financial results or comply withSEC reporting requirements.  In addition,if the officers of MTI are not able to make the certifications required underthe Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and SEC rules, ourofficers may not be able to make their required certifications.  As a result, we may be subject to SECenforcement action and civil litigation, and our stock price may decline.

 

***If we become profitable, we cannot assure you that our net operatinglosses will be available to reduce our tax liability.***

 

Our ability to use, or theamount 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 ofshares of our common stock issued in our initial public offering may besufficient, taking into account prior or future shifts in our ownership over athree-year period, 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 its affiliates will be able toinfluence matters requiring stockholder approval and could discourage thepurchase of our outstanding shares at a premium.***

 

As of November 1, 2005,Warburg Pincus beneficially owned approximately 76% of our outstanding commonstock.  This concentration of ownershipmay have the effect of delaying, preventing or deterring a change in control ofour company, could deprive our stockholders of an opportunity to receive a premiumfor their common stock as part of a sale or merger of our company and maynegatively affect the market price of our common stock. Transactions that couldbe affected by this concentration of ownership include proxy contests, tenderoffers, mergers or other purchases of common stock that could give you theopportunity to realize a premium over the then-prevailing market price forshares of our common stock.

 

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As a result of Warburg Pincus’share ownership and representation on our board of directors, Warburg Pincus isable to influence all affairs and actions of our company, including mattersrequiring stockholder approval, such as the election of directors and approvalof significant corporate transactions. The interests of our principal stockholder may differ from the interestsof the other stockholders.  For example,Warburg Pincus could oppose a third party offer to acquire us that our otherstockholders might consider attractive, and the third party may not be able orwilling to proceed unless Warburg Pincus supports the offer.  In addition, if our board of directorssupports a transaction requiring an amendment to our certificate ofincorporation, Warburg Pincus is currently in a position to defeat any requiredstockholder approval of the proposed amendment. If our board of directors supports an acquisition of us by means of amerger or a similar transaction, the vote of Warburg Pincus alone is currentlysufficient to approve or block the transaction under Delaware law. In each ofthese cases and in similar situations, you may disagree with Warburg Pincus asto whether the action opposed or supported by Warburg Pincus is in the bestinterest of our stockholders.

 

***Certain of our principal stockholders may have conflicts of interestswith our other stockholders or us in the future.***

 

Certain of our principalstockholders, including Warburg Pincus, may make investments in companies andfrom time to time acquire and hold interests in businesses that competedirectly or indirectly with us.  These otherinvestments 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 principal stockholdersmay have an interest in our company pursuing acquisitions, divestitures,financings or other transactions that, in their judgment, could enhance theirequity investment, even though such transactions might involve risks to ourstockholders.  In addition, theseprincipal stockholders’ rights to vote or dispose of equity interests in ourcompany are not subject to restrictions in favor of our company other than asmay 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 corporategovernance requirements.***

 

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 of thedirectors coming up for reelection each year. Having a staggered board makes it more difficult for a third party toobtain control of our board of directors through a proxy contest, which may bea necessary step in an acquisition of us that is not favored by our board ofdirectors.

 

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“business combination” with that person for three years without specialapproval, which could discourage a third party from making a takeover offer andcould delay or prevent a change of control. For purposes of Section 203, “interested stockholder” means,generally, someone owning 15% or more of our outstanding voting stock or anaffiliate of ours that owned 15% or more of our outstanding voting stock duringthe past three years, subject to certain exceptions as described inSection 203.  Under one suchexception, Warburg Pincus does not 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 maintain and improve the effectiveness of our disclosurecontrols and procedures and internal controls over financial reporting,significant resources 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, the Sarbanes-OxleyAct, as well as rules subsequently implemented by the SEC and the NASDAQNational Market System, have required changes in our corporate governancepractices.  These rules and regulationshave increased our legal and financial compliance costs significantly and makesome activities more time-consuming and costly. For example, in anticipation of becoming a public company, we createdadditional board committees and adopted policies regarding internal controlsand disclosure controls and procedures. In addition, we incur additional costs associated with our publiccompany reporting requirements.  We alsoexpect these rules and regulations to make it more difficult and more expensivefor us to obtain director and officer liability insurance and we may berequired to accept reduced policy limits and coverage or incur substantiallyhigher costs to obtain the same or similar coverage.  As a result, it may be more difficult for usto attract and retain qualified persons to serve on our board of directors oras executive officers.

 

***If we identify another material weakness in our internal control overfinancial reporting, our ability to report our financial results on a timelyand accurate basis may be adversely affected.***

 

In connection with theiraudits of our consolidated financial statements for the years endedDecember 31, 2003 and 2004, our independent registered public accountingfirm reported two conditions, which together constituted a material weakness inthe internal controls over our ability to produce financial statements freefrom material misstatements.  A materialweakness is a control deficiency, or combination of control deficiencies, thatresults in more than a remote likelihood that a material misstatement of theannual or interim financial statements will not be prevented or detected.  Our independent registered public accountingfirm reported to us that we did not have a sufficient number of senior levelfinancial personnel, and our controls over non-routine transactions did notensure that accounting considerations were identified and appropriatelyrecorded.  These two conditions, incombination, constituted a material weakness in our internal control overfinancial reporting.

 

Our management and auditcommittee agreed that the conditions identified by our independent registeredpublic accounting firm constituted a material weakness.   We developed a plan to address this materialweakness that included the addition of a new chief financial officer, a directorof 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 June2005 to ensure adequate time for transition to our new full-timeemployees.  Effective April 2005, wehired a new chief financial officer, who has 19 years of experience in themedical device manufacturing industry working for both public and privatecompanies.  We also hired a newcontroller in April 2005, who came to us from a Big Four public accounting firmand has significant experience 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 additional seniorstaff level accounting position.   Withthe addition of these individuals, we believe that we have sufficient, skilledpersonnel to reasonably ensure that we have the ability to produce financialstatements free from material misstatements. We have also engaged a consulting firm to assist us in assessing ourinternal control over financial reporting and remediating any controldeficiencies. As a result of these measures, we have concluded that thematerial weakness that existed in our internal control over financial reportinghas been fully remediated as of October 2, 2005. However, we will continue toassess the adequacy and appropriateness of our financial staff and adjustaccordingly 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 any future material weaknesses or to implementrequired new or improved controls, or difficulties encountered in their implementation,could harm our operating results, cause us to fail to meet our reportingobligations or result in material misstatements in our consolidated financialstatements.  Any such failure also couldadversely affect the results of the periodic management evaluations and annualauditor attestation reports regarding the effectiveness of our “internalcontrol over financial reporting” that will be required when the Securities andExchange Commission’s rules under Section 404 of the Sarbanes-Oxley Actbecome applicable to us, which depending upon whether we qualify as an“accelerated filer” under the Exchange Act rules could be as early as ourannual report on Form 10-K for the year ending December 31, 2006 tobe filed in early 2007.  Inadequateinternal controls could also cause investors to lose confidence in our reportedfinancial 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 rulesand regulations 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.              QUANTITATIVEAND QUALITATIVE DISCLOSURES 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, ofour 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 not denominatedin U.S. dollars, if there is an increase in the rate at which a foreigncurrency is exchanged for U.S. dollars, it will require more of the foreigncurrency to equal a specified amount of U.S. dollars than before the rateincrease.  In such cases and if we priceour products in the foreign currency, we will receive less in U.S. dollars thanwe 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 ANDPROCEDURES**

 

**Evaluation ofDisclosure Controls and Procedures**

 

We maintain disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended) that are designed to reasonablyensure that information required to be disclosed by us in the reports we fileor submit under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized, and reported, within the time periods specified in theSecurities and Exchange Commission’s rules and forms and that such informationis accumulated 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 evaluatingour 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 theparticipation of our Chief Executive Officer and Chief Financial Officer, theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered in this quarterly report on Form10-Q.  Based on that evaluation, ourChief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures were effective as of the end of such periodto provide reasonable assurance that information required to be disclosed inour Exchange Act reports is recorded, processed, summarized, and reportedwithin the time periods specified in the SEC’s rules and forms, and thatmaterial information relating to our company and our consolidated subsidiariesis made known to management, including our Chief Executive Officer and ChiefFinancial Officer, particularly during the period when our periodic reports arebeing prepared.

 

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**Changes inInternal Control Over Financial Reporting**

 

In connection with theiraudits of our consolidated financial statements for the years endedDecember 31, 2003 and 2004, our independent registered public accountingfirm reported two conditions, which together constitute a material weakness inthe internal controls over our ability to produce financial statements freefrom material misstatements.  Ourindependent 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 controls.

 

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 our newfull-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 public accountingfirm and has significant experience 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 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 controls over financialreporting has been fully remediated as of October 2, 2005. However, we willcontinue to assess the adequacy and appropriateness of our financial staff andadjust 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 materially affected,or is reasonably likely to materially affect, our internal control overfinancial reporting.

 

**PART II - OTHER INFORMATION**

 

**ITEM 1.  LEGALPROCEEDINGS**

 

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.  InAugust 2001, the court issued a written decision that EDC I coil devicesdid infringe the plaintiff’s patents, enjoined Dendron from selling the deviceswithin Germany and from Germany to physician customers abroad, and requestedthat Dendron disclose the individual products’ costs as the basis for awardingdamages.  In September 2001, Dendronappealed the decision.  In addition,Dendron instituted challenges to the validity of each of these patents byfiling opposition proceedings with the European Patent Office, or EPO, againstone of the 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.  InApril 2002, the Court found that EDC I coil devices did infringe theplaintiff’s patent.  The patent involvedis the same patent that was involved in the case before the English PatentsCourt discussed below and that was ruled by a Dutch court to be invalid, alsodiscussed below.  The oppositionproceedings on the patent are complete, and the EPO has rejected the oppositionand has upheld the validity of the patent. The case is under appeal and an oral hearing is scheduled to be held inthe Dusseldorf Court 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 thousand wasrecorded  in accrued liabilities in ourconsolidated financial statements included in this report.  Dendron ceased all activities with respect tothe EDC I coil device prior to MTI’s October 2002 acquisition 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 sinceSeptember 27, 2002.  InFebruary 2005, MTI received an initial claim from the patent holders withrespect to monetary damages, amounting to €3.6 million, or approximately$4.3 million as of October 2, 2005, with which MTI disagrees.  Court hearings will be held regarding theseclaims.  MTI has filed an appeal with theDutch court, and believes that since the date of injunction in each separatecountry it is in compliance with the Dutch court’s injunction and MTI intendsto continue such compliance. Because we believe that MTI has valid legalgrounds for appeal, we have determined that a loss is not probable at this timeas defined by SFAS 5, *Accounting forContingencies.*  However, therecan be no assurance that the ultimate resolution of this matter will not resultin a material adverse effect on our business, financial condition or results ofoperations.

 

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 inOctober 2003 to 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 March2005.  The parties intend to continuediscussions regarding payment by the patent holders of the remaining costsincurred by MTI in such litigation.  As aresult of the interim settlement, MTI anticipates that it will no longer beinvolved in litigation in the United Kingdom, although no assurance can begiven that no other litigation involving MTI may arise in the United Kingdom.

 

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 certain deliverycatheters.  In October 2003, the courtdismissed MTI’s actions for procedural reasons without prejudice and withoutdecision 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 datehas not been set. Because these matters are in early stages, we cannot estimatethe possible loss or range of loss, if any, associated with theirresolution.  However, there can be noassurance that the ultimate resolution of these matters will not result in amaterial adverse effect on our business, financial condition or results ofoperations.

 

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 four milestonesto which payments relate. The first milestone was required by its terms tobe achieved by January 1, 2005 in order to trigger a payment equal to$50 million.  We have determined that the first milestone was notachieved by January 1, 2005 and that the first milestone is notpayable. On May 20, 2005, Michael Lesh, as an individual seller ofAppriva stock and  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 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  this motion in January 2006. The parties havenot engaged in any discovery.  On August5, 2005, our attorneys received a letter from attorneys representing certainother sellers of Appriva stock (who are not purported to be represented in theaction filed by Lesh), asking our attorneys to enter into a dialogue regardingtheir assertions that certain milestones should have been paid. We believetheir assertions 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 the Court ofChancery 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 theopportunity 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 of theproposed transaction; (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 of theclass for all damages sustained as a result of the defendants’ conduct; (5)directing that the defendants account to the plaintiff and other members of theclass for all profits and any special benefits obtained as a result of theirconduct; (6) costs and disbursements of the lawsuit, including attorneys’ feesand expenses; and (7) such other relief as the court may find just andproper.  ev3 believes this lawsuit iswithout merit and 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 endedOctober 2, 2005 pursuant to the exercise of options to purchase shares of ourcommon stock under the ev3 LLC 2003 incentive plan.  Except for these issuances, there were noother unregistered sales by us of our equity securities during the quarter endedOctober 2, 2005.

 

Nounderwriting commissions or discounts were paid with respect to the sales ofthe unregistered securities described above. In addition, all of the above sales were made in reliance on Rule 701,Regulation D and Section 4(2) under the Securities Act of 1933, as amended (the“Securities Act”).  With regard to ourreliance upon the exemptions under Regulation D and Section 4(2) under theSecurities Act, certain inquiries of the purchasers were made by us toestablish that such sales qualified for such exemptions from the registrationrequirements.  With regard to ourreliance upon the Rule 701 exemption, all such issuances were to employees,former employees or independent consultants.

 

**Use of Proceeds**

 

On June 15, 2005, ourregistration statement on Form S-1 (Registration No. 333-123851) was declaredeffective.  Our initial public offeringresulted 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 and availablecash were used as follows:  $36.5 millionof the net proceeds were used to repay a portion of the accrued and unpaidinterest on the demand notes, $18.9 million for general corporate purposes andthe remaining net proceeds were invested in short-term, investment-grade,interest bearing securities.  We cannotpredict whether the proceeds will yield a favorable return. Other than $36.5million of the net proceeds used to repay a portion of the accrued and unpaidinterest on demand notes held by Warburg Pincus, which is our majoritystockholder, and Vertical, which is one of our stockholders, none of the netproceeds from our initial public offering have resulted in direct or indirectpayments to directors, officers or their associates, to persons who owned 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 futureperiodic reports.

 

**IssuerPurchases of Equity Securities**

 

We did not purchase any sharesof our common stock or other equity securities registered pursuant to Section12 of the Securities Exchange Act of 1934, as amended, during the quarter endedOctober 2, 2005, and our board of directors has not authorized any repurchaseplan or program for purchase of our shares of common stock or other equitysecurities on the open market or otherwise.

 

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**ITEM 3.  DEFAULTS UPONSENIOR SECURITIES**

 

Not applicable.

 

**ITEM 4.  SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS**

 

Not applicable.

 

**ITEM 5.  OTHERINFORMATION**

 

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. (Filed  herewith) |
|            | 10.3       |            | Form of Non-Statutory Option  Grant Notice under ev3 Inc. 2005 Incentive Stock Plan (Filed herewith) |
|            | 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 thisreport to be signed on its behalf by the undersigned, hereunto duly authorized.

 
| November 15, 2005 | **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-QEXHIBIT 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.                                                    |                 | Filed herewith. |
|            | 10.3       |            | Form of Non-Statutory Option  Grant Notice under ev3 Inc. 2005 Incentive Stock Plan                                                                 |                 | Filed herewith. |
|            | 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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