##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 
 FORM 10-Q [X]         Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
 For the quarterly period ended March 31, 2004
Commission File No. 0-18602 ATS MEDICAL, INC.  Minnesota
(State or other jurisdiction of
incorporation or organization)
    
    41-1595629
(I.R.S. Employer Identification No.)
 3905 Annapolis Lane N., Suite 105
Minneapolis, Minnesota
(Address of principal executive offices)
    
    55447
(Zip Code)
 Registrants telephone number, including area code: (763) 553-7736 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock $.01 par value Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).  The number of shares outstanding of each of the registrants classes of
common stock as of April 29, 2004, was: Common Stock, $.01 par value
    
    26,924,464 shares




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INDEX Page(s)PART I. FINANCIAL INFORMATIONITEM 1. Financial Statements (Unaudited)Consolidated Balance Sheets as of
March 31, 2004, and December 31, 2003
    
    
    3Statements of Operations for the three
months ended March 31, 2004 and 2003
    
    
    4Statements of Cash Flows for the three
months ended March 31, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements
    
    
    6 - 7ITEM
2. Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    8 - 17ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    18ITEM 4. Controls and Procedures
    
    
    18PART II. OTHER INFORMATIONITEM 2. Changes in Securities and Use of Proceeds
    
    
    19ITEM 6. Exhibits and Reports on Form 8-K
    
    
    19SIGNATURES
    
    
    20EXHIBIT INDEX
    
    
    21Certification Pursuant to Section 302Certification Pursuant to Section 302Certification Pursuant to Section 906Certification Pursuant to Section 906
  2




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PART I. FINANCIAL INFORMATION 
 ITEM 1. Financial Statements ATS Medical, Inc. 
 Consolidated Balance Sheets (in thousands, except per share and share data) March 31,
    
    December 31,2004
    
    2003(unaudited)AssetsCurrent assets:Cash and cash equivalents
    
    $
    6,233
    
    
    $
    6,472Short-term investments
    
    
    1,753
    
    
    
    2,003Accounts receivable, net
    
    
    5,859
    
    
    
    4,939Inventories
    
    
    20,689
    
    
    
    20,377Other current assets
    
    
    717
    
    
    
    508Total current assets
    
    
    35,251
    
    
    
    34,299
Furniture, machinery and equipment, net
    
    
    5,738
    
    
    
    5,895Inventories
    
    
    13,000
    
    
    
    17,000Technology license
    
    
    18,500
    
    
    
    18,500Other assets
    
    
    435
    
    
    
    440Total assets
    
    $
    72,924
    
    
    $
    76,134Liabilities and shareholders equityCurrent liabilities:Accounts payable
    
    $
    1,122
    
    
    $
    989Due to related party
    
    
    217
    
    
    
    217Accrued payroll and expenses
    
    
    1,086
    
    
    
    1,343Accrued distributor liabilities
    
    
    616
    
    
    
    475Total current liabilities
    
    
    3,041
    
    
    
    3,024
Due to related party
    
    
    253
    
    
    
    307Shareholders equity:Common stock, $.01 par value:authorized 40,000,000 shares; issued and
outstanding 26,814,089 and 26,778,557 shares at
March 31, 2004 and December 31, 2003
    
    
    268
    
    
    
    268Additional paid-in capital
    
    
    123,555
    
    
    
    123,412Deferred compensation
    
    
    (70
    )
    
    
    (70
    )Accumulated other comprehensive income
    
    
    40
    
    
    
    51Accumulated deficit
    
    
    (54,163
    )
    
    
    (50,858
    )Total shareholders equity
    
    
    69,630
    
    
    
    72,803Total liabilities and shareholders equity
    
    $
    72,924
    
    
    $
    76,134
 The accompanying notes are an integral part of the consolidated financial statements. 3




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ATS Medical, Inc. 
 Consolidated Statements of Operations
   Three months ended March 31,2004
    
    2003Net sales
    
    $
    6,694
    
    
    $
    3,965Cost of goods sold
    
    
    4,766
    
    
    
    2,748Gross profit
    
    
    1,928
    
    
    
    1,217Operating expenses:Sales and marketing
    
    
    3,666
    
    
    
    1,154Research and development
    
    
    187
    
    
    
    386General and administrative
    
    
    1,381
    
    
    
    987Total operating expenses
    
    
    5,234
    
    
    
    2,527Operating loss
    
    
    (3,306
    )
    
    
    (1,310
    )Net interest income (expense)
    
    
    1
    
    
    
    (229
    )Net loss
    
    ($
    3,305
    )
    
    ($
    1,539
    )Net loss per shareBasic and diluted
    
    ($
    0.12
    )
    
    ($
    0.07
    )Weighted average number of shares used in calculationBasic and diluted
    
    
    26,802
    
    
    
    22,318
 The accompanying notes are an integral part of the consolidated financial statements. 4




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ATS Medical, Inc. 
 Consolidated Statements of Cash Flow
   Three months ended March 31,2004
    
    2003Cash flows from operating activitiesNet loss
    
    ($
    3,305
    )
    
    ($
    1,539
    )Adjustments to reconcile net loss to net cash
used in operating activities:Depreciation
    
    
    265
    
    
    
    184Compensation expense on stock options
    
    
    25
    
    
    
    1Imputed interest long-term debt
    
    
    
    
    
    
    160Changes in operating assets and liabilities:Accounts receivable
    
    
    (920
    )
    
    
    (653
    )Inventories
    
    
    3,688
    
    
    
    2,460Prepaid expenses
    
    
    (209
    )
    
    
    (171
    )Other assets
    
    
    4
    
    
    
    4Accounts payable and accrued expenses
    
    
    (36
    )
    
    
    (766
    )Net cash used in operating activities
    
    
    (488
    )
    
    
    (320
    )
Cash flows from investing activitiesPurchase of short-term investments
    
    
    (996
    )
    
    
    (1,500
    )Sale of short-term investments
    
    
    1,246
    
    
    
    995Purchases of furniture, machinery and equipment
    
    
    (108
    )
    
    
    (130
    )Net cash provided by (used in) investing activities
    
    
    142
    
    
    
    (635
    )
Cash flows from financing activitiesNet proceeds from sale of common stock
    
    
    118
    
    
    
    8Net cash provided by financing activities
    
    
    118
    
    
    
    8Effect of exchange rate changes on cash
    
    
    (11
    )
    
    
    1Decrease in cash and cash equivalents
    
    
    (239
    )
    
    
    (946
    )
Cash and cash equivalents at beginning of period
    
    
    6,472
    
    
    
    7,472Cash and cash equivalents at end of period
    
    $
    6,233
    
    
    $
    6,526
 The accompanying notes are an integral part of the consolidated financial statements. 5




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ATS Medical, Inc. 
 Notes to Consolidated Financial Statements
 (Unaudited)
 Note 1. Basis of Presentation The consolidated financial statements included in this Form 10-Q have been
prepared by ATS Medical, Inc. without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC). The consolidated
financial statements include the accounts of the company and its subsidiaries,
and all significant inter-company accounts and transactions are eliminated in
consolidation. Certain information and footnote disclosures normally included
in financial statements prepared in accordance with accounting principles
generally accepted in the United States have been condensed or omitted pursuant
to these rules and regulations. The year-end balance sheet was derived from
audited financial statements, but does not include all disclosures required by
accounting principles generally accepted in the United States. These unaudited
consolidated interim financial statements should be read in conjunction with
the Companys consolidated financial statements and related notes included in
its Annual Report on Form 10-K for 2003. These statements reflect, in managements opinion, all adjustments (which
include only normal, recurring adjustments) necessary for a fair presentation
of the financial position and the results of operations and cash flows for the
periods presented. The results of operations for any interim period may not be
indicative of results for the full year. Note 2. Stock-Based Compensation The Company accounts for its stock-based employee compensation plan under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. The exercise price of
the Companys employee stock options generally equals the market price of the
underlying stock on the date of grant for all options granted, and thus, under
APB 25, no compensation expense is recognized. Stock options granted to
non-employees are valued and accounted for in accordance with Financial
Accounting Statement No. 123, Accounting for Stock-Based Compensation(FAS
123). Accordingly, these costs are charged to operating expenses over the
vesting period of the option. The following table illustrates the effect on net loss and net loss per share
if the Company had applied the fair value recognition provisions of FAS 123 to
stock-based employee compensation. Three months endedMarch 31,(in thousands, except per share data)
    
    2004
    
    2003Net loss, as reported
    
    ($
    3,305
    )
    
    ($
    1,539
    )
Subtract: Total stock-based employee compensation
expense determined under fair value based
method for all awards
    
    
    (673
    )
    
    
    (103
    )Pro forma net loss
    
    ($
    3,978
    )
    
    ($
    1,642
    )Net loss per share:As reportedBasic and diluted
    
    ($
    0.12
    )
    
    ($
    0.07
    )Pro formaBasic and diluted
    
    ($
    0.15
    )
    
    ($
    0.07
    )
 6




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Note 3. Inventories Inventories consist of the following: March 31,
    
    December 31,(in thousands)
    
    2004
    
    2003Raw materials
    
    $
    10,380
    
    
    $
    12,033Work in process
    
    
    8,755
    
    
    
    9,615Finished goods
    
    
    14,754
    
    
    
    15,929Obsolescence reserve
    
    
    (200
    )
    
    
    (200
    )Total, net
    
    $
    33,689
    
    
    $
    37,377Balance sheet classificationCurrent assets
    
    $
    20,689
    
    
    $
    20,377Non-current assets
    
    
    13,000
    
    
    
    17,000Total, net
    
    $
    33,689
    
    
    $
    37,377
 The Company maintains significant levels of inventory that exceed current
demand. Management believes that these excess quantities will be utilized over
several years. Therefore, the Company has classified $13.0 million and $17.0
million of inventories as noncurrent assets at March 31, 2004 and December 31,
2003, respectively. Note 4. Comprehensive Income Comprehensive income for the Company includes net income from foreign currency
translation which is charged or credited to the cumulative translation account
within shareholders equity. Gains and losses from foreign currency
translation are not material. Note 5. New Pronouncements In December 2003, the FASB issued FASB Interpretation No. 46R (FIN 46R),
Consolidation of Variable Interest Entities, which addresses how a business
enterprise should evaluate whether it has a controlling financial interest in
an entity through means other than voting rights and accordingly should
consolidate the entity. The Company believes it has no variable interest
entities and, therefore, FIN 46R did not have an impact on the Companys
consolidated financial statements. Note 6. Subsequent Event On April 26, 2004 the Company signed an exclusive development and licensing
agreement with ErySave AB and made an initial milestone payment of
approximately $0.2 million. The agreement grants the Company worldwide rights
for ErySaves filtration technology for cardiac surgery procedures. Payments
under the agreement, based upon the achievement of certain development
milestones, could total approximately $1.3 million. 7




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ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations The following Managements Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements within the meaning of
the Private Securities Litigation Reform Act of 1995. Words such as may,
expect, believe, anticipate, or estimate, identify such forward-looking
statements. These statements by their nature involve substantial risks and
uncertainties, and actual results may differ materially from those expressed in
such forward-looking statements. Some of the factors that could cause such
material differences are identified in Cautionary Statements. We undertake
no obligation to correct or update any forward-looking statements, whether as a
result of new information, future events, or otherwise. You are advised,
however, to consult any future disclosures we make on related subjects in
future filings with the SEC. Executive Overview We manufacture and market a mechanical bileaflet heart valve with a patented
pivot design. Our heart valve is used to treat valvular heart disease caused
by the natural aging process, rheumatic heart disease and congenital defects. Sulzer Carbomedics (Carbomedics) developed the basic design from which the
ATS heart valve evolved. Carbomedics is a large and experienced manufacturer of
pyrolytic carbon components used in mechanical heart valves. Carbomedics has
also designed and patented numerous mechanical valves. Carbomedics offered to
license a patented and partially developed valve to us if we would complete the
development of the valve and agree to purchase carbon components from
Carbomedics. We hold an exclusive, royalty-free, worldwide license to an open
pivot, bileaflet mechanical heart valve design owned by Carbomedics from which
the ATS heart valve has evolved. In addition, we have an exclusive, worldwide
right and license to use Carbomedics pyrolytic carbon technology to
manufacture components for the ATS heart valve. We commenced selling the ATS heart valve in international markets in 1992. In
October 2000, we received FDA approval to sell the ATS Open Pivot® MHV and
commenced sales and marketing of our valve in the United States. The original
sales forecasts as well as the pricing models that were used when the original
Supply Agreement was signed with Carbomedics proved to be too optimistic.
Accordingly, to keep the Supply Agreement active and the license to sell the
valve exclusive, we purchased quantities of inventory far in excess of demand. From 1990 through 2002, we paid Carbomedics approximately $125 million for the
development of our valve, the technology to manufacture our pyrolytic carbon
components, and for pyrolytic valve components manufactured by Carbomedics.
On December 31, 2002, we had remaining payments due under the Technology
Agreement that totaled $28 million. This led us in 2003 to negotiate an
accelerated but reduced payment for all outstanding debts to Carbomedics
related to the Technology Agreement. In August 2003, we paid $12 million to
satisfy all future obligations under this Agreement. With inventory purchases exceeding sales through the years, we have built
inventory levels that today provide a source of cash. We are drawing down
these paid-for inventories and using the cash it generates to fund operations.
Our manufacturing facility for pyrolytic carbon components has been producing
limited quantities. We expect to increase production in this facility sometime
in 2004 but are carefully considering our options as this decision will require
the use of cash as we buy raw materials and hire production workers. Once we
have exhausted our high priced components, we expect to have lower
manufacturing costs per valve which will allow us to realize gross profit in
these international markets. In June 2002, we reorganized the company laying off more than half of the work
force including all executive management. With the hiring of a new president
late in 2002, we have started the process of rebuilding our sales and marketing
teams, especially in the United States. This rebuilding is the most
significant factor contributing to our increase in expense levels during 2003
and into 2004. Because sales prices in the United States exceed selling prices
elsewhere, we feel that our future success will depend on achieving increased
market share in the U.S. Our U.S. sales as a percentage of our overall sales
have grown from 4% in 2000 to 36% in the first quarter of 2004. Critical Accounting Policies and Estimates We base our estimates on historical experience and on various other assumptions
that we believe to be reasonable under the circumstances. Managements
discussion and analysis of financial condition and results of operations are
based upon the consolidated financial statements, 8




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which have been prepared in
accordance with accounting principles generally accepted in the United States. The preparation of these
financial statements requires us to make estimates and judgments that affect
(1) the reported amounts of assets, liabilities, revenues, and expenses; and
(2) the related disclosure of contingent assets and liabilities. At each
balance sheet date, we evaluate our estimates and judgements. The critical
accounting policies that are most important to fully understanding and
evaluating the financial condition and results of operations are discussed in
our most recent Annual Report on Form 10-K on file with the SEC. Results of Operations The following table compares the dollar and percentage change in the Statements
of Operations for the three month periods ended March 2004 and 2003. Three months ended March 31,Increase2004
    
    2003
    
    (Decrease)
    
    %Net sales
    
    $
    6,694
    
    
    $
    3,965
    
    
    $
    2,729
    
    
    
    68.8
    %Cost of goods sold
    
    
    4,766
    
    
    
    2,748
    
    
    
    2,018
    
    
    
    73.4
    %Gross profit
    
    
    1,928
    
    
    
    1,217
    
    
    
    711
    
    
    
    58.4
    %Gross profit %
    
    

    28.8
    %
    
    
    30.7
    %Operating expenses:Sales and marketing
    
    
    3,666
    
    
    
    1,154
    
    
    
    2,512
    
    
    
    217.7
    %Research and development
    
    
    187
    
    
    
    386
    
    
    
    (199
    )
    
    
    -51.6
    %General and administrative
    
    
    1,381
    
    
    
    987
    
    
    
    394
    
    
    
    39.9
    %Total operating expenses
    
    
    5,234
    
    
    
    2,527
    
    
    
    2,707
    
    
    
    107.1
    %Operating loss
    
    
    (3,306
    )
    
    
    (1,310
    )
    
    
    (1,996
    )
    
    
    152.4
    %
Net interest income (expense)
    
    
    1
    
    
    
    (229
    )
    
    
    230
    
    
    
    100.4
    %
Net loss
    
    ($
    3,305
    )
    
    ($
    1,539
    )
    
    ($
    1,766
    )
    
    
    114.7
    %
 The following table presents the statement of operations as a percentage of net
sales for the three month periods ended March 2004 and 2003. Three months endedMarch 31,2004
    
    2003Net sales
    
    
    100.0
    %
    
    
    100.0
    %Cost of goods sold
    
    
    71.2
    %
    
    
    69.3
    %Gross profit
    
    
    28.8
    %
    
    
    30.7
    %Operating expenses:Sales and marketing
    
    
    54.8
    %
    
    
    29.1
    %Research and development
    
    
    2.8
    %
    
    
    9.7
    %General and administrative
    
    
    20.6
    %
    
    
    24.9
    %Total operating expenses
    
    
    78.2
    %
    
    
    63.7
    %Operating loss
    
    
    -49.4
    %
    
    
    -33.0
    %
Net interest income (expense)
    
    
    0.0
    %
    
    
    -5.8
    %
Net loss
    
    
    -49.4
    %
    
    
    -38.8
    %
 9




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Net sales.The following table compares net sales between the three month
periods ended March 2004 and 2003. Three months ended March 31,(in thousands)
    
    2004
    
    2003
    
    Increase
    
    %United States
    
    $
    2,390
    
    
    $
    853
    
    
    $
    1,537
    
    
    
    180.2
    %Outside United States
    
    
    4,304
    
    
    
    3,112
    
    
    
    1,192
    
    
    
    38.3
    %Total
    
    $
    6,694
    
    
    $
    3,965
    
    
    $
    2,729
    
    
    
    68.8
    %
 2004 Change inAverageSales
    
    UnitPrice
    
    SalesUnited States
    
    
    6.8
    %
    
    
    162.4
    %Outside United States
    
    
    -20.5
    %
    
    
    74.0
    %Total
    
    
    -7.9
    %
    
    
    83.3
    %
 Three months endedMarch 31,2004
    
    2003Share of total sales:United States
    
    
    35.7
    %
    
    
    21.5
    %Outside United States
    
    
    64.3
    %
    
    
    78.5
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
 In June 2002, the majority of our U.S. sales persons were terminated. In the
fourth quarter of 2002, we hired a new CEO and began building our new sales
organization in the U.S. consisting of four area directors managing 28 sales
territories. Our representation within these territories now consists of both
direct sales representatives and independent agents. This new sales
organization and overall greater sales efforts contributed to our increase in
sales in 2004 as compared to 2003 and to our sales within the U.S. accounting
for a larger percentage of overall sales. During 2003 we aggressively entered several international markets that
represented opportunities for greater sales unit growth but at prices lower
than our other markets. Prices in some of these territories are lower than our
current manufacturing costs. We feel this strategy is reasonable because it
allows us to increase our market share while reducing our high priced, but paid
for inventories. Once we have exhausted our high priced components, we expect
to have lower manufacturing costs per valve which will allow us to realize
gross profit in these international markets. Cost of good sold.Our costs of goods sold as a percentage of net sales has
varied due to changes in average selling price. Our gross margin is anticipated
to improve as sales within the Unites States increase as a percentage of total
sales and as we start selling valves that have been entirely manufactured in
our facilities. Our inventories of high priced carbon components currently
exceed our expected sales during 2004. The ATS valve is made of materials that do not deteriorate. Other than the
need to resterilize them periodically, there is no risk of perishability.
Pyrolytic carbon, which is the substrate used in manufacturing our valves, has
been the only material used to manufacture mechanical heart valves for humans
for many years and remains the most advanced raw material for our products.
The other sources of prosthetic heart valves for humans are cadaver and porcine
tissues, however, obsolescence issue because of this are remote because of
certain advantages offered by mechanical heart valves including superior
durability. Similarly, we believe that, given the lead time that would be
required, there is no material risk that there would be the introduction and
FDA approval of another substrate that would replace pyrolytic carbon prior to
the end of the period over which we expect to sell our inventory of valves. 10




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To date, all purchased pyrolytic carbon components for the ATS heart valve have
come from Carbomedics, Inc. (Carbomedics), pursuant to a multi-year supply
agreement entered into in 1990. The cost of the pyrolytic carbon
components represents approximately 80% of the total cost of the ATS heart
valve. Under the supply agreement, the cost of the pyrolytic carbon components
has varied according to annual volume purchases and was adjusted annually by
reference to increases in the U.S. Department of Labor Employment Cost Index. The supply agreement with Carbomedics is still in effect but has been
re-negotiated several times. Our current obligations under the supply
agreement call for future purchase obligations starting in 2007 and continuing
through 2010. We maintain significant levels of carbon components in inventory that exceed
current demand due to past purchase requirements under the supply agreement.
In addition, the cost of these components has been high and at times exceeded
selling prices necessitating lower of cost or market write-downs of
inventories. We have set up our own manufacturing facility and we expect to
increase the production of our own carbon components during 2004. In future
years, as higher priced inventory purchased from Carbomedics is replaced by
lower cost inventory that we manufacture, cost of goods sold will decrease as a
percentage of net sales. Sales and marketing.Cost increases in 2004 over 2003 were for the building of
our new sales and marketing organizations. We have substantially completed
the hiring and training of our new sales and marketing organizations. Research and development.Research and development expenses include the costs
to develop and improve current and future products and the costs for regulatory
and clinical activities for these products. In addition, during 2003, the
costs to set up and maintain our carbon components manufacturing facility while
it was in pre-production mode and the operational qualification and validation
of the carbon production equipment and making pilot coating runs were charged
to research and development costs and totaled approximately $268,000 during the
three months ended March 2003. General and administrative.Cost increases in 2004 over 2003 were for employee
salary and benefits of $0.3 million and higher corporate insurance costs of
$0.1 million. Net interest income (expense).Our interest expense was primarily attributable
to imputed interest on our long-term debt previously owed to Centerpulse. Our
interest income is primarily attributable to the investment of our cash
balances. Income taxes.At the end of 2003,we have accumulated approximately $42
million of net operating loss (NOL) carryforwards for U.S. tax purposes. We
believe that our ability to fully utilize the existing NOL carryforwards could
be restricted on a portion of the NOL for changes in control that may have
occurred or may occur in the future. We have not conducted a formal study of
whether a change in control of ATS has occurred in the past that impairs our
NOL carryforwards because we are unable to utilize such NOL carryforwards until
we achieve profitability and because this study would be very expensive to
complete. When we attain profitability, we will conduct a formal study of any
restrictions on our carryforwards. We have not recorded any net assets related
to our NOL carryforwards and other deferred items as we currently cannot
determine that it is reasonably likely that this asset will be realized and we,
therefore, have provided a valuation allowance for the entire asset. Net loss.Our increase in net loss in 2004 compared to 2003 resulted from
changes in sales offset by changes in operating costs, all of which are
described above. Liquidity and Capital Resources Cash, cash equivalents and short-term investments were $8.0 million as of March
31, 2004 compared to $8.5 million as of December 31, 2003. Operating activities.During the quarter ended March 2004 we received cash
payments from customers of $5.8 million. We made cash payments to employees
and suppliers of $6.3 million. Our operating loss during 2004 of $3.3 million
was substantially funded through the depletion of inventories. During 2003 and
into 2004, we incurred significant expenses commercializing the ATS heart valve
in the United 11




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States. As we build sales in future
periods and our cost of
inventories decrease, our operating losses will decrease and we will move
steadily towards a cash flow breakeven on sales and eventually to
profitability. Investing and financing activities.We historically have funded our operations
through equity investments. During the first three months of 2004 we
purchased property and equipment totaling $0.1 million. Our current level of
property and equipment is adequate to support operations in 2004 and purchases
of equipment for the remainder of 2004 will approximate the amount spent in the
just completed quarter. Cash Management During 2004 and into 2005, we expect to increase production of pyrolytic carbon
components in our own manufacturing facility. This will require the use of
cash as we purchase raw materials and hire employees to make the inventory.
Current inventory levels are adequate into 2005. We estimate that operating
costs will remain high in comparison to sales during 2004 and 2005 and will
require the use of cash to fund operations. We will draw down cash balances to
build inventories and fund operations during 2004 and 2005. On April 26, 2004 the Company signed an exclusive development and licensing
agreement with ErySave AB and made an initial milestone payment of
approximately $0.2 million. The agreement grants the Company worldwide rights
for ErySaves filtration technology for cardiac surgery procedures. Payments
under the agreement, based upon the achievement of certain development
milestones, could total approximately $1.3 million. Based upon the current forecast of sales and operating expenses, we anticipate
having cash to fund our operations through 2004. However, as identified under
the heading of Cautionary Statements below, any adverse change that affects
our revenue, access to the capital markets or future demand for our products
will affect our long term viability. Maintaining adequate levels of working
capital depends in part upon the success of our products in the marketplace,
the relative profitability of those products and our ability to control
operating and capital expenses. Funding of our operations in future periods may
require additional investments in ATS in the form of equity, debt or a
combination of both. There can be no assurance that we will achieve desired
levels of sales or profitability, or that future capital infusions will be
available. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements (as such term is defined in
Item 303 of Regulation S-K) that are reasonably likely to have a current or
future effect on our financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or
capital resources. Cautionary Statements This document contains forward-looking statements within the meaning of federal
securities laws that may include statements regarding intent, belief or current
expectations of our Company and our management. The Private Securities
Litigation Reform Act of 1995 provides a safe harbor for forward-looking
statements to encourage companies to provide prospective information without
fear of litigation so long as those statements are identified as
forward-looking and are accompanied by meaningful cautionary statements
identifying important factors that could cause actual results to differ
materially from those projected in the statement. We desire to take advantage
of these safe harbor provisions. Accordingly, we hereby identify the
following important factors which could cause our actual results to differ
materially from any such results which may be projected, forecast, estimated or
budgeted by us in forward-looking statements made by us from time to time in
reports, proxy statements, registration statements and other written
communications, or in oral forward-looking statements made from time to time by
the companys officers and agents. We do not intend to update any of these
forward-looking statements after the date of this Form 10-K to conform them to
actual results. If our heart valve does not achieve widespread market acceptance in the United
States, our operating results will be harmed and we may not achieve
profitability. Our success will depend, in large part, on the medical communitys acceptance
of the ATS heart valve in the United Sates, which is the largest revenue market
in the world for heart valves. The U.S. medical communitys acceptance of the
ATS heart valve will depend upon our ability to 12




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demonstrate the safety and
efficacy, advantages, long-term clinical performance and cost-effectiveness of
the ATS heart valve as compared to other prosthetic heart valves. We cannot
predict whether the U.S. medical community will accept the ATS heart valve or,
if accepted, the extent of its use. Negative publicity resulting from isolated
incidents involving the ATS heart valve or other prosthetic heart
valves could have a significant adverse effect on the overall acceptance of our
heart valve. If we encounter difficulties developing a market for the ATS heart
valve in the United States, we may not be able to increase our revenue enough
to achieve profitability and our business and results of operations will be
seriously harmed. We currently rely on the ATS heart valve as our sole source of revenue. If we
are not successful in selling this product, our operating results will be
harmed. We have developed only one product, which is currently being sold primarily
outside the United States. Even if we were to develop additional products,
regulatory approval would likely be required to sell them. Clinical testing and
the approval process itself are very expensive and can take many years.
Therefore, we do not expect to be in a position to sell additional products in
the foreseeable future. Adverse rulings by regulatory authorities, product
liability lawsuits, the failure to achieve widespread U.S. market acceptance,
the loss of market acceptance outside of the United States, or other adverse
publicity may significantly and adversely affect our sales of the ATS heart
valve, and, as a result, would adversely affect our business, financial
condition and results of operations. In 2002 we began using a combination of direct sales persons and independent
manufacturing representatives to sell our valves in the United States. If our
new U.S. sales strategy is not successful, we will not be able to continue our
operations as planned. Our sales approach for the sale of the ATS valve in the United States consists
primarily of direct salespersons with a few independent manufacturers
representatives. We will need to continue to expend significant funds and
management resources to develop and maintain this hybrid sales force. We
believe there is significant competition for sales personnel and independent
manufacturing representatives with the advanced sales skills and technical
knowledge we need. If we are unable to recruit, retain and motivate qualified
personnel and representatives, U.S. sales of the ATS valve could be adversely
affected. The loss of key salespersons or independent manufacturers
representatives could have a material adverse effect on our sales or potential
sales to current customers and prospects serviced by such salespersons or
representatives. Further, we cannot assure the successful expansion of our
network of independent manufacturers representatives on terms acceptable to
ATS, if at all, or the successful marketing of our products by our hybrid sales
force. To the extent we rely on sales through independent manufacturers
representatives, any revenues we receive will depend primarily on the efforts
of these parties. We do not control the amount and timing of marketing
resources that these third parties devote to our product. If our U.S. sales
strategy is not successful, we may be forced to change our U.S. sales strategy
again. Any such change could disrupt sales in the United States. Further, any
change in our U.S. sales strategy could be expensive and would likely have a
material adverse impact on our results of operations. We currently depend on the marketing and sales efforts of international
independent distributors, and our sales have been concentrated in three
countries. The ATS heart valve is sold internationally through independent distributors.
The loss of an international distributor could seriously harm our business and
results of operations if a new distributor could not be found on a timely basis
in the relevant geographic market. We do not control the amount and timing of
marketing resources that these third parties devote to our product.
Furthermore, to the extent we rely on sales through independent distributors,
any revenues we receive will depend primarily on the efforts of these parties. We are dependent upon sales outside the United States, which are subject to a
number of risks including a drop in sales due to currency fluctuations. As March 31, 2004, 64% of our net sales are derived from international
operations. We expect that international sales will account for a substantial
majority of our revenue until the ATS heart valve receives wider market
acceptance from U.S. customers. Accordingly, any material decrease in foreign
sales may materially and adversely affect our results of operations. We sell in U.S. dollars to most of our customers abroad. An increase in the
value of the U.S. dollar in relation to other currencies can and has adversely
affected our sales outside of the United States. In prior years, the decrease
in sales was due primarily to the change in the value of the 13




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U.S. dollar
against the Euro, as well as competitor price pressure. Our dependence on sales
outside of the United States will continue to expose us to U.S. dollar currency
fluctuations for the foreseeable future. Our future results of operations could also be harmed by risks inherent in
doing business in international markets, including:  
    
    unforeseen changes in regulatory requirements and government health programs;
    
    weaker intellectual property rights protection in some countries;
    
    new export license requirements, changes in tariffs or trade restrictions;
    
    political and economic instability in our target markets; and
    
    greater difficulty in collecting payments from product sales. In 2001, we experienced a slow collection of receivables from our Italian
distributor. As a result, we ceased recognizing sales to this distributor upon
shipment, and instead recognize sales to this distributor only upon receipt of
payment. Slow payment of receivables by other international distributors, or
the occurrence of any of the other factors listed above, could harm our ability
to successfully commercialize our product internationally and could harm our
business. We have a history of net losses. If we do not have net income in the future,
we may be unable to continue our operations. We are not currently profitable and have a very limited history of
profitability. As of March 31, 2004, we had an accumulated deficit of $54.2
million. We expect to incur significant expenses over the next several years
as we continue to devote substantial resources to the commercialization of the
ATS heart valve in the United States. We will not generate net income unless
we are able to significantly increase revenue from U.S. sales. If we continue
to sustain losses, we may not be able to continue our business as planned. The market for prosthetic heart valves is highly competitive, and a number of
our competitors are larger and have more financial resources. If we do not
compete effectively, our business will be harmed. The market for prosthetic heart valves is highly competitive. We expect that
competition will intensify as additional companies enter the market or modify
their existing products to compete directly with us. Our primary competitor,
St. Jude Medical, Inc., currently controls approximately 50% of the worldwide
mechanical heart valve market. Many of our competitors have long-standing FDA
approval for their valves and extensive clinical data demonstrating the
performance of their valves. In addition, they have greater financial,
manufacturing, marketing and research and development capabilities than we
have. For example, many of our competitors have the ability, due to their
internal carbon manufacturing facilities and economies of scale, to manufacture
their heart valves at a lower cost than we can manufacture our ATS heart valve.
Our primary competitor has recently used price as a method to compete in
several international markets. If heart valve prices decline significantly we
might not be able to compete successfully, which would harm our results of
operations. Our future results will be harmed if the use of mechanical heart valves
declines. Our business could suffer if the use of mechanical heart valves declines.
Historically, mechanical heart valves have accounted for over two-thirds of all
heart valve replacements. Recently, there has been an increase in the use of
tissue valves. We estimate that mechanical heart valves are currently being
used in 40 to 65% of all heart valve replacements, depending on the geographic
market, down from 65 to 75% about ten years ago. We believe the tissue
manufacturers claims of improvements in tissue valve longevity and an increase
in the average age of valve patients have contributed to the recent increase in
the use of tissue valves. New products or technologies developed by others could render our product
obsolete. The medical device industry is characterized by significant technological
advances. Several companies are developing new prosthetic heart valves based on
new or potentially improved technologies. Significant advances are also being
made in surgical procedures, which may delay the need for replacement heart
valves. A new product or technology may emerge that renders the ATS heart valve
noncompetitive or obsolete. This could materially harm our results of
operations or force us to cease doing business altogether. 14




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We maintain a large volume of inventory, which exceeds the current demand for
the ATS heart valve. If sales of our product do not increase, the value of our
inventory could decrease substantially. We purchased pyrolytic carbon components under a long-term supply agreement
with Carbomedics, Inc. (formerly Sulzer Carbomedics, Inc.) through June 2002
and we are required to resume purchases of such components in 2007. To date,
our purchases of pyrolytic carbon components have exceeded our sales of the ATS
heart valves. We currently have in inventory enough pyrolytic carbon components
to satisfy our projected requirements through 2004. If we are unable to achieve
widespread acceptance for the ATS heart valve or if competitive pressures
result in price reductions, the value of the excess inventory would likely
decrease, which could seriously harm our results of operations and financial
condition. Because the pyrolytic carbon components are made to meet the unique
specifications of the ATS heart valve, our inventory may have little, if any,
value in the open market. We license patented technology and other proprietary rights from Carbomedics.
If these agreements are breached or terminated, our right to manufacture the
ATS heart valve could be terminated. Under our carbon technology agreement with Carbomedics, we have obtained a
license to use Carbomedics pyrolytic carbon technology to manufacture
components for the ATS heart valve. If this agreement is breached or
terminated, we would be unable to manufacture our own product. If our inventory
is exhausted and we do not have any other sources of carbon components, we
would be forced to cease doing business. A delay or interruption in the supply of pyrolytic carbon components could
delay product delivery or force us to cease operations. We cannot be certain that, after our current inventory is exhausted, sufficient
quantities of pyrolytic carbon components will be available to assemble the ATS
heart valve. Other than our carbon facility, the only other FDA-approved
alternate supplier of our pyrolytic carbon components is Carbomedics. Although
we have a supply agreement with Carbomedics under which it agrees to supply us
with a minimum annual number of pyrolytic carbon components in 2007 through
2011, the amounts available under this agreement are not expected to be
sufficient to supply all of our needs for components in those years. If our
inventory is exhausted and we are unable to manufacture carbon components or
obtain them from other sources, we could be forced to reduce or cease
operations. Because we lack manufacturing experience, we may not realize expected savings
from manufacturing our own product. In addition, we could experience production
delays and significant additional costs. Under our agreement with Carbomedics, we have been granted an exclusive
worldwide license to manufacture pyrolytic carbon components for the ATS heart
valve. We cannot be certain that our strategy to establish internal
manufacturing capabilities will result in a cost-effective means for
manufacturing the ATS heart valve. We have limited experience in manufacturing
pyrolytic carbon. Although we have an FDA-approved carbon manufacturing
facility, it is currently operating at the minimal level necessary to maintain
the plant and our technical expertise in producing carbon components. In the
future when we increase production at the plant we may encounter difficulties
in maintaining and expanding our manufacturing operations, including problems
involving:  
    
    production yields;
    
    quality control;
    
    per unit manufacturing costs;
    
    shortages of qualified personnel; and
    
    compliance with FDA and international regulations and
requirements regarding good manufacturing practices. Difficulties encountered by us in establishing or maintaining a
commercial-scale manufacturing facility may limit our ability to manufacture
our heart valve and therefore could seriously harm our business and results of
operations. Our business could be seriously harmed if third-party payors do not reimburse
the costs for our heart valve. Our ability to successfully commercialize the ATS heart valve depends on the
extent to which reimbursement for the cost of our product and the related
surgical procedure is available from third-party payors, such as governmental
programs, private insurance plans and managed care 15




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organizations. Third-party
payors are increasingly challenging the pricing of medical products and
procedures that they consider are not cost-effective or are used for a
non-approved indication. The failure by physicians, hospitals and other users
of our product to obtain sufficient reimbursement from third-party payors would
seriously harm our business and results of operations. In recent years, there have been numerous proposals to change the health care
system in the United States. Some of these proposals have included measures
that would limit or eliminate payment for medical procedures or treatments. In
addition, government and private third-party payors are increasingly attempting
to contain health care costs by limiting both the coverage and the level of
reimbursement. In international markets, reimbursement and health care payment
systems vary significantly by country. In addition, we have encountered price
resistance from government-administered health programs. Significant changes in
the health care system in the United States or elsewhere, including changes
resulting from adverse trends in third-party reimbursement programs, could have
a material adverse effect on our business and results of operations. We may face product liability claims, which could result in losses in excess of
our insurance coverage and which could negatively affect our ability to attract
and retain customers. The manufacture and sale of mechanical heart valves entail significant risk of
product liability claims and product recalls. A mechanical heart valve is a
life-sustaining device and the failure of any mechanical heart valve usually
results in the patients death or need for reoperation. A product liability
claim or product recall, regardless of the ultimate outcome, could require us
to spend significant time and money in litigation or to pay significant damages
and could seriously harm our business. We currently maintain product liability
insurance coverage in an aggregate amount of $25 million. However, we cannot
assure you that our current insurance coverage is adequate to cover the costs
of any product liability claims made against us. Product liability insurance is
expensive and does not cover the costs of a product recall. In the future,
product liability insurance may not be available at satisfactory rates or in
adequate amounts. A product liability claim or product recall could also
materially and adversely affect our ability to attract and retain customers. Our business would be adversely affected if we are not able to protect our
intellectual property rights. Our success depends in part on our ability to maintain and enforce our patents
and other proprietary rights. We rely on a combination of patents, trade
secrets, know-how and confidentiality agreements to protect the proprietary
aspects of our technology. These measures afford only limited protection and
competitors may gain access to our intellectual property and proprietary
information. The patent positions of medical device companies are generally
uncertain and involve complex legal and technical issues. Litigation may be
necessary to enforce our intellectual property rights, to protect our trade
secrets and to determine the validity and scope of our proprietary rights. Any
litigation could be costly and divert our attention from the growth of the
business. We cannot assure you that our patents and other proprietary rights
will not be successfully challenged, or that others will not independently
develop substantially equivalent information and technology or otherwise gain
access to our proprietary technology. We may be sued by third parties which claim that our product infringes on their
intellectual property rights. Any such suits could result in significant
litigation or licensing expenses or we might be prevented from selling our
product. We may be exposed to future litigation by third parties based on intellectual
property infringement claims. Any claims or litigation against us, regardless
of the merits, could result in substantial costs and could harm our business.
In addition, intellectual property litigation or claims could force us to:  
    
    cease manufacturing and selling our product, which would
seriously harm us;
    
    obtain a license from the holder of the infringed
intellectual property right, which license may not be available on
reasonable terms, if at all; or
    
    redesign our product, which could be costly and
time-consuming. We are subject to extensive governmental regulation, which is costly, time
consuming and can subject us to unanticipated delays. The ATS heart valve and our manufacturing activities are subject to extensive
regulation by a number of governmental agencies, including the FDA and
comparable international agencies. We are required to: 16




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
    
    maintain the approval of the FDA and international regulatory
agencies to continue selling the ATS heart valve;
    
    obtain the approval of international regulatory agencies in
countries where the ATS heart valve is not yet marketed;
    
    satisfy content requirements for all of our labeling, sales and promotional materials;
    
    comply with manufacturing and reporting requirements; and
    
    undergo rigorous inspections by these agencies. Compliance with the regulations of these agencies may delay or prevent us from
introducing any new or improved products. Violations of regulatory requirements
may result in fines, marketing restrictions, product recall, withdrawal of
approvals and civil and criminal penalties. The price of our common stock has been volatile, which may result in losses to
investors. Historically, the market price of our common stock has fluctuated over a wide
range and it is likely that the price of our common stock will fluctuate in the
future. The market price of our common stock could be impacted by the
following:  
    
    the success of our management in operating ATS effectively;
    
    the failure of the ATS valve to gain market acceptance in the United States;
    
    announcements of technical innovations or new products by our competitors;
    
    the status of component supply arrangements;
    
    changes in reimbursement policies;
    
    government regulation;
    
    developments in patent or other proprietary rights;
    
    public concern as to the safety and efficacy of products developed by us or others; and
    
    general market conditions. In addition, due to one or more of the foregoing factors, in future years, our
results of operations may fall below the expectations of securities analysts
and investors. In that event, the market price of our common stock could be
materially and adversely affected. Finally, in recent years the stock market
has experienced extreme price and volume fluctuations. This volatility has had
a significant effect on the market prices of securities issued by many
companies for reasons unrelated to their operating performance. These broad
market fluctuations may materially adversely affect our stock price, regardless
of our operating results. Our charter documents and Minnesota law may discourage and could delay or
prevent a takeover of our company. Provisions of our articles of incorporation, bylaws and Minnesota law could
make it more difficult for a third party to acquire us, even if doing so would
be beneficial to our shareholders. These provisions include the following:  
    
    No cumulative voting by shareholders for directors;
    
    The ability of our board to set the size of the board of
directors, to create new directorships and to fill vacancies;
    
    The ability of our board, without shareholder approval, to
issue preferred stock, which may have rights and preferences that
are superior to our common stock;
    
    The ability of our board to amend the bylaws; and
    
    Restrictions under Minnesota law on mergers or other business
combinations between us and any holder of 10% or more of our
outstanding common stock. 17




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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk The primary objective of our investments activities is to preserve principal
while at the same time maximizing the income we receive from our investments
without significantly increasing risk. Some of the securities that we
invest in may have market risk. This means that a change in prevailing
interest rates may cause the fair market value of the principal amount of
the investment to fluctuate. For example, if we hold a security that was
issued with a fixed interest rate at the then prevailing rate and the
prevailing interest rate later rises, the fair value of the principal amount
of our investment will probably decline. To minimize this risk, our
portfolio of cash equivalents and short-term investments may be invested in
a variety of securities, including commercial paper, money market funds, and
both government and non-government debt securities. The average duration of
all our investments has generally been less than one year. Due to the
short-term nature of these investments, we believe we have no material
exposure to interest rate risk arising from our investments. In the United States, Canada, and France, we sell our products directly to
hospitals. In other international markets, we sell our products to
independent distributors who, in turn, sell to medical hospitals. Loss,
termination, or ineffectiveness of distributors to effectively promote our
product would have a material adverse effect on our financial condition and
results of operations. Transactions with U.S. and non-U.S. customers and distributors, other than
in France, are entered into in U.S. dollars, precluding the need for foreign
currency hedges on such sales. Sales through our French subsidiary, which
was established in 2002 to replace a distributor, are in Euros, so we are
subject to profitability risk arising from exchange rate movements. We have
not used foreign exchange contract or similar devices to reduce this risk.
We will evaluate the need to use foreign exchange contracts or similar
devices, if sales in France increase substantially. We do not believe that inflation has had a material effect on our results of
operations in recent years and periods. There can be no assurance, however,
that our business will not be adversely affected by inflation in the future. 
 ITEM 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures Under the supervision and with the participation of our management, including
our Chief Executive Officer and our Chief Financial Officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15(f) under the Exchange Act). Based upon
that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of the period covered by this report, our
disclosure controls and procedures were effective in timely alerting them to
the material information relating to us required to be included in our periodic
SEC filings. (b) Changes in Internal Control During the most recent fiscal quarter, there has been no change in our internal
controls over financial reporting (as defined in Rule 13a-15(f) under the
Exchange Act) that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting. 18




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PART II. OTHER INFORMATION 
 ITEM 2. Changes in Securities and Use of Proceeds None 
 ITEM 6. Exhibits and Reports on Form 8-K (a)
    Exhibits31.1
    
    
    Certification of Chief Executive
Officer pursuant to Rules 13a-15(e)/15d-15(e) (Section
302 Certification)31.2
    
    
    Certification of Chief Financial
Officer pursuant to Rules 13a-15(e)/15d-15(e) (Section
302 Certification)32.1
    
    
    Certification of the Chief Executive
Officer pursuant to 18 U.S.C. Section 1350 (Section 906
Certification)32.2
    
    
    Certification of the Chief Financial
Officer pursuant to 18 U.S.C. Section 1350 (Section
906 Certification)(b)
    
    Reports on Form 8-KThe Company furnished (in accordance with Item 12 of Form
8-K) to the SEC a Form 8-K as follows:On January 9, 2004, our results of operations and
financial condition for the fiscal quarter ended
December 31, 2003.On February 11, 2004, our results of operations and
financial condition for the fiscal quarter ended
December 31, 2003.On April 29, 2004, our results of operations and
financial condition for the fiscal quarter ended March
31, 2004.
 19




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Date: May 10, 2004
    ATS MEDICAL, INC.By:
    /s/ Michael D. DaleMichael D. Dale, Chief Executive Officer(Principal Executive  Officer and
Authorized Signatory) By:
    /s/ John R. JuddJohn R. Judd, Chief Financial Officer

(Principal Accounting Officer) 20




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EXHIBIT INDEX Exhibit Number
    
    Description31.1
    
    Certification of the Chief Executive Officer pursuant to
Rules 13a-15(e)/15d-15(e) (Section 302 Certification)31.2
    
    Certification of the Chief Financial Officer pursuant to
Rules 13a-15(e)/15d-15(e) (Section 302 Certification)32.1
    
    Certification of the Chief Executive Officer pursuant to 18
U.S.C. Section 1350 (Section 906 Certification)32.2
    
    Certification of the Chief Financial Officer pursuant to 18
U.S.C. Section 1350 (Section 906 Certification)
 21