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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number: 000-30959
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RITA MEDICAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3199149
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
967 N. Shoreline Blvd.
Mountain View, CA 94043
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: 650-314-3400
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.001 par value
(Title of Class)
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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 than the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $53,027,474 as of February 28, 2002, based upon
the closing sale price on the Nasdaq National Market reported for such date.
Shares of Common Stock held by each officer and director and by each person who
owns 5% or more of the outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.
There were 14,630,671 shares of the registrant's Common Stock issued and
outstanding as of February 28, 2002.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the definitive proxy
statement for the
2002 annual meeting of shareholders to be filed in April 2002.
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PART I
Item 1. Business.
Overview
We are a medical device company that develops, manufactures and markets
minimally invasive products to treat patients with solid cancerous or benign
tumors. Our proprietary system uses radiofrequency energy to heat tissue to a
high enough temperature to ablate it, or cause cell death. The RITA system
includes radiofrequency generators and a family of disposable needle electrode
devices that deliver controlled thermal energy to the targeted tissue.
We are currently focused on addressing the liver cancer market, and we
believe our system offers a viable option to patients who previously had few or
no effective alternatives. We estimate that the worldwide market opportunity
for the radiofrequency ablation of unresectable liver cancer is approximately
$500 million annually. In addition to liver cancer, we believe that our
minimally invasive technology may in the future be applied to the treatment of
other types of cancerous or benign tumors, including tumors of the bone, lung,
breast, uterus, prostate and kidney. We believe the market opportunity for
these additional applications exceeds $1 billion annually.
We have received regulatory clearance for sale in major markets worldwide,
including the United States. In March 2000, RITA became the first
radiofrequency ablation company to receive specific FDA clearance for
unresectable liver lesions in addition to its previous general FDA clearance
for the ablation of soft tissue. Our system is distributed in the United States
through our direct sales force and internationally through distribution
partners. Since our product launch, we have sold over 35,000 disposable devices.
RITA has a broad patent portfolio. As of February 28, 2002, we had 46 issued
patents worldwide and more than 50 United States and foreign patent
applications pending. The issued patents cover, among other things, deployable
multi-array electrode technology and temperature feedback technology.
Market Opportunity
Cancer Market
Millions of people throughout the world are afflicted with cancer. Only
heart disease kills more people in the United States every year.
Cancer can be categorized into two broad groups: solid tumor cancers, such
as liver, lung, bone, breast, prostate and kidney cancers as well as
hematologic or blood-borne cancers, such as lymphomas and leukemias.
Approximately 90 percent of all cancers are solid tumor cancers.
Liver Cancer Market
There are two forms of liver cancer: primary and metastatic. Primary liver
cancer originates in the liver. Secondary, or metastatic, liver cancer
originates elsewhere in the body and spreads to the liver. A significant number
of patients treated for primary and metastatic liver cancer experience a
recurrence of their disease.
The worldwide incidence of primary liver cancer is estimated to be one
million new patients each year. The vast majority of primary liver cancer
patients are located outside the United States, particularly in Asia and
Southern Europe. Approximately 90 percent of patients diagnosed with primary
liver cancer will die within five years. Due to a rise in the number of
worldwide cases of Hepatitis B and C, both of which are correlated to the
development of primary liver cancer, we believe that the incidence of primary
liver cancer may increase in the future.
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It is estimated that there are almost as many cases of metastatic liver
cancer worldwide as there are cases of primary liver cancer and approximately
300,000 annual cases in the United States alone. The liver is one of the most
common sites for the spread of cancer. For example, one of the most common
forms of primary cancer is colorectal cancer, and approximately 60 percent of
these patients will develop metastatic liver tumors. Due to numerous factors,
including the absence of viable treatment options, metastatic liver cancer
often causes death.
Treatment Options for Liver Cancer
The prognosis for primary and secondary liver cancer is poor. Although
limited treatment options are currently available for liver cancer, they are
typically ineffective, are generally associated with significant side effects
and can even cause death. Traditional treatment options include surgery,
chemotherapy, cryosurgery, percutaneous ethanol injection and radiation therapy.
Surgery
While surgery is considered the "gold standard" treatment option to address
liver tumors, approximately 70 to 90 percent of liver cancer patients are
unresectable, which means they do not qualify for surgery. This is most often
due to the following:
. Operative risk: limited liver function or poor patient health threatens
survival as a result of the surgery; or
. Technical feasibility: the proximity of a cancerous tumor to a critical
organ or artery, or the size, location on the liver or number of tumors
makes surgery infeasible.
For the few patients who qualify for surgery, there are significant
complications related to the procedure and the operative mortality rate is two
percent. One-year recurrence rates following surgery have been reported to be
as low as 12 percent; however, when tumors recur, surgery typically cannot be
repeated.
Chemotherapy
Chemotherapy uses drugs to kill cancer cells. Chemotherapy can be used
systemically or locally. In systemic chemotherapy, drugs are delivered
throughout the body. In local chemotherapy, drugs are delivered directly to the
liver tumor. Systemic chemotherapy is not considered an effective means of
treating liver cancer. In some cases, treatment regimens using localized
chemotherapy in addition to systemic treatment have been reported to increase
the efficacy of these alternatives to a limited extent.
Chemotherapy causes significant side effects in the majority of patients,
including loss of appetite, nausea and vomiting, hair loss and ulcerations of
the mouth. In addition, chemotherapy can damage the blood-producing cells of
the bone marrow, leading to a low blood cell count. As a result, chemotherapy
patients have an increased chance of infection, bleeding or bruising after
minor cuts or injuries, and fatigue or shortness of breath.
Cryosurgery
Cryosurgery is the destruction of cancer cells using sub-zero temperatures
in an open surgical procedure. During cryosurgery, multiple stainless steel
probes are placed into the center of the tumor and liquid nitrogen is
circulated through the end of the device, creating an ice ball. Cryosurgery
involves a cycle of treatments in which the tumor is frozen, allowed to thaw
and then refrozen.
While cryosurgery is considered to be relatively effective with one-year
local recurrence rates of approximately 10 percent, we believe adoption of this
procedure has been limited by the following factors:
. it is not an option for patients who cannot tolerate an open surgical
procedure;
. it involves significant complications which are similar to other open
surgical procedures, as well as liver fracture and hemorrhaging caused by
the cycle of freezing and thawing;
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. it is associated with mortality rates estimated to be between one and five
percent; and
. it is expensive compared to other alternatives.
Percutaneous Ethanol Injection
Percutaneous ethanol injection, or PEI, involves the injection of alcohol
into the center of the tumor. The alcohol causes cells to dry out and cellular
proteins to disintegrate, ultimately leading to tumor cell death.
While PEI can be successful in treating some patients with primary liver
cancer and has a reported one-year local recurrence rate of approximately 13
percent, it is generally considered ineffective on large tumors as well as
metastatic tumors. Patients are required to receive multiple treatments, making
this option unattractive for many patients. Complications include pain and
alcohol introduction to bile ducts and major blood vessels. In addition, this
procedure can cause cancer cells to be deposited along the needle tract when
the needle is withdrawn.
Radiation Therapy
Radiation therapy uses high dose x-rays to kill cancer cells. Radiation
therapy is not considered an effective means of treating liver cancer and is
rarely used for this purpose.
The RITA Solution
Our Procedure
Our proprietary system is designed to use radiofrequency energy to provide a
minimally invasive approach to ablating solid cancerous or benign tumors. Our
system delivers radiofrequency energy to raise the temperature of cells above
45 to 50(degrees)C, causing cellular death.
The physician inserts the RITA disposable needle electrode device into the
target body tissue, typically under ultrasound guidance. Once the device is
inserted, pushing on the handle of the device causes a group of curved wires to
be deployed from the tip of the electrode. When the power is turned on, these
wires deliver radiofrequency energy throughout the tumor. In addition,
temperature sensors on the tips of the wires measure tissue temperature
throughout the procedure. During the procedure, our system automatically
adjusts the amount of energy delivered in order to maintain the temperature
necessary to ablate the targeted tissue. For a typical five centimeter ablation
using our latest product, the ablation process takes approximately ten minutes.
When the ablation is complete, pulling back on the handle of the device causes
the curved wire array to be retracted into the device so it can be removed from
the body. Our disposable device cauterizes the tissue along the needle tract,
which we believe kills any residual cancer cells that might be removed from the
tumor.
Benefits of the RITA System
The benefits of our system include:
. Effective Treatment Option. We believe that our system provides an
effective treatment option to liver cancer patients who previously had few
options available to effectively address their unresectable liver tumors.
In the future, our system may offer patients with other types of tumors a
better treatment option.
. Minimally Invasive Procedure. The RITA system offers physicians an
effective minimally invasive treatment option with few side effects or
complications. Our products can be used in an outpatient procedure that
requires only local anesthesia, and patients are typically sent home the
same day with a small bandage over the entry site. Alternatively, patients
can be treated laparoscopically and are generally sent home the next day.
Compared to existing alternatives, we believe our minimally invasive
procedure is cost effective and can result in reduced hospital stays.
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. Proprietary Array Design and Temperature Feedback Provide Procedural
Control. Our array design enables the physician to predictably ablate
large volumes of targeted tissue. In addition, our temperature feedback
feature allows physicians to ensure that the temperature is high enough
throughout the tissue to achieve cell death.
. Repeat Treatments Possible. Liver cancer is a recurrent disease. However,
due to the invasive nature of other treatment options, the majority of
patients who undergo traditional therapies cannot be retreated in the
event that new tumors appear on their livers. Because of the minimally
invasive nature of our procedure, patients treated with our system can
often be retreated.
. Broadly Applicable Technology. Our extensive clinical experience with
liver tumors and feasibility studies in other organs indicates that our
technology may in the future be broadly applied to the ablative treatment
of solid tumors in the lung, bone, breast, prostate and kidney.
While there are numerous benefits of our system, there are some side effects
of treatment as well. Published reports on the use of the RITA system indicate
low overall complication rates. These include ground-pad burns, which are burns
that can occur when there is a concentration of heat at the ground-pad site,
bleeding and abscesses. Studies have also shown some recurrence of tumors
following treatment with our system. However, in many cases where tumors recur,
our procedure can be repeated. In rare cases, physician misuse of our system
has resulted in patient deaths.
Our Business Strategy
Our goal is to be the leading provider of minimally invasive devices for the
treatment of solid cancerous or benign tumors. To achieve this goal, we plan to
do the following:
. Increase Our Penetration of the Liver Cancer Market. We believe we can
capitalize on the opportunity to increase our penetration of the market
for the radiofrequency ablation of unresectable liver tumors, which is
currently estimated to be $500 million annually. We intend to execute this
strategy by doing the following:
. increase awareness among key physicians through sales, marketing and
training programs; in 2001 we trained over 400 physicians worldwide.
. publish additional clinical research to provide data supporting the
expanded use of our products;
. drive patient awareness with marketing efforts and an expanded Internet
site focused on educating patients on the benefits of the RITA system;
in 2001 we launched livertumor.org, a patient education and referral
website, and
. broaden our market coverage by expanding our domestic direct sales force
and international distribution channels; in 2001, we more than doubled
the number of sales personnel in the United States.
. Expand the Application of Our Proprietary Technology to Markets Beyond
Liver Cancer. We believe our minimally invasive proprietary technology
can be broadly applied to the treatment of other types of cancerous and
benign tumors, including tumors in the bone, lung, breast, prostate,
uterus and kidney. We plan to build on our extensive clinical experience
in liver tumors as well as feasibility studies in additional organs to
support the extension of our technology to additional applications in the
future. We estimate that the market for these additional applications
exceeds $1 billion annually.
. Continue to Advance Technology. We intend to aggressively pursue ongoing
research and development of additional products and technologies. We plan
to continue to expand and improve our product offerings to better serve
patients with solid cancerous or benign tumors whose needs are not met by
existing treatments. For example, in 2001, we launched the Starburst XLi
disposable needle which is capable of a 7 centimeter ablation, about 4
times the volume of our previous generation.
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Our Technology and Products
Technology
All of our products are based on our proprietary radiofrequency technology
that is used to ablate tissue in a controlled manner. A radiofrequency
generator supplies energy through our disposable device placed within the
targeted tissue. Our devices contain curved, space-filling arrays of wires
which are deployed from the tip to allow the radiofrequency energy to be
dispersed throughout the tumor.
Radiofrequency energy supplied by the generator produces ionic agitation, or
cellular friction, in the tissue closely surrounding the electrode. This
friction produces heat that can be used to predictably ablate volumes of
tissue. To effectively ablate tissue, it must be heated to an approximate
temperature of 45 to 50(degrees)C, or 113 to 122(degrees)F.
Our system is designed to permit the physician to set the desired treatment
time and temperature at the beginning of the procedure. Once that temperature
is reached, our proprietary temperature control technology automatically
adjusts the energy supplied from the generator to maintain the optimal
temperature within the tissue during the course of the procedure. We believe
our system has the potential to provide a more effective ablation than
competing technologies by providing critical tissue temperature feedback during
the procedure.
Products
The RITA system consists of a radiofrequency generator and a family of
disposable devices. The following chart summarizes our current product
offerings.
Year of U.S. List
Product Name Description Introduction Price
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Disposable Model 70 Creates a scalable 2 to 3 centimeter ablation. 1999 $ 1,100
Devices: Compatible with the Model 500 generator.
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StarBurst Creates a scalable 2 to 3 centimeter ablation. 2000 $ 1,100
Compatible with the Model 1500 generator.
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StarBurst XL Creates a scalable 3 to 5 centimeter ablation. 2000 $ 1,440
Compatible with the Model 1500 generator.
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5 cm Starburst XLi Creates a scalable 4 to 5 centimeter ablation. 2001 $ 2,195
Compatible with the Model 1500 generator
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7 cm Starburst XLi Creates a scalable 4 to 7 centimeter ablation. 2001 $ 2,495
Compatible with the Model 1500 generator
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Generators: Model 500 50 Watt Generator 1997 $30,000
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Model 1500 150 Watt Generator 2000 $37,500
Disposable Devices
Our disposable devices all consist of needle shaped electrodes containing
curved wire arrays that are deployed into the targeted body tissue. Each device
contains several thermocouples, or temperature sensors, which provide feedback
to the physician of the tissue temperature during the ablation and which allow
the generator to automatically adjust the amount of radiofrequency energy so
that the desired tissue temperature can be achieved.
Our disposable devices are available in different array sizes to allow the
physician to create a spherical ablation volume of anywhere from two to seven
centimeters. Three centimeters is slightly smaller than a ping-
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pong ball. Seven centimeters is approximately the size of a tennis ball. In
addition, depending on product line, the devices are available in 10,12,15 or
25 centimeter lengths to allow physicians to access tumors that are located
more or less deeply within the body. Each disposable device is supplied with
one or more ground pads to allow a return path for the flow of radiofrequency
energy from the patient back to the generator. Sales of disposable devices
accounted for 78% of sales for the year ended December 31, 2001, 67% of sales
for the year ended December 31, 2000 and 64% of sales for the year ended
December 31, 1999.
Generators
All of our generators employ an internal computer to assist the physician in
safely and effectively controlling the delivery of radiofrequency during the
ablation. In addition, each generator has a display to convey information to
the physician while using the system. Our Model 1500 generators have the
ability, using optional software running on a laptop computer, to display
real-time, color-coded graphs of power, temperature and impedance to aid the
user in controlling the system and to collect procedural information for the
patient's record. Sales of generators accounted for 22% of sales for the year
ended December 31, 2001, 33% of sales for the year ended December 31, 2000 and
36% of sales for the year ended December 31, 1999.
Sales and Marketing
We have a geographically diverse customer base which includes the United
States, Europe and Asia. Our customers include surgical oncologists,
hepatobiliary surgeons, liver transplant surgeons, laparoscopists and
interventional radiologists. We also target patient referral sources, including
colorectal surgeons and medical oncologists. Revenue from customers in the
United States totaled $8.0 million for the year ended December 31, 2001, $3.9
million for the year ended December 31, 2000 and $1.7 million for the year
ended December 31, 1999. Revenue from customers outside of the United States
totaled $6.8 million for the year ended December 31, 2001, $6.1 million for the
year ended December 31, 2000 and $2.9 million for the year ended December 31,
1999.
In the United States, we market our products through a direct sales force of
26 sales representatives and six regional managers. Overseas, we market our
products through distribution partners. To date, we have entered into
agreements with distributors in 40 countries including the major countries in
Europe and Asia. RITA has four full-time sales managers who are responsible for
directing, supporting and monitoring our international distributors' activities.
Our marketing and sales efforts are directed at placing generators at key
cancer centers and other leading medical centers worldwide and then working
with those centers' physicians to increase their usage of our disposable
devices. We recognize that our predominant source of recurring revenue will be
from our disposable devices, which can only be used once a generator is placed.
To facilitate generator placement at medical centers, we have established a
variety of programs, including long- or short-term loan, preferred customer
discount, and leasing referral programs.
We plan to continue to drive physician adoption by increasing awareness of
the RITA system among potential users. We have established relationships with
leading physicians at prominent cancer and other leading medical institutions,
many of whom we believe are now strong advocates of our products. To increase
adoption of our system, we are involving these physicians in formal courses,
doctor-to-doctor preceptorship programs and hands-on training programs. We also
offer programs to assist our customers in marketing the benefits of the RITA
system to referring clinical oncologists and colorectal surgeons. In addition,
since cancer treatment options are often affected by patient choice, we are
expanding public awareness in this area through a new patient education
Internet site.
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Clinical Research
To date, there have been over 55 publications in peer-reviewed journals on
clinical studies using our products. An additional eight articles appeared in
the November/December 2000 Special Supplement of The Cancer Journal. Over 50
abstracts on our products have been presented at medical conferences. These
published and presented reports include over 500 patients. The majority of
these clinical studies have been conducted on patients with unresectable liver
cancer. These studies have demonstrated that liver tumors can be ablated safely
and effectively using the RITA system.
In addition, clinicians have investigated or are currently investigating the
feasibility of using our system to address other types of cancer, including
tumors of the breast, lung, bone, prostate and kidney, and initial results in
bone, lung and breast clinical investigations have been published or presented.
In a recent study published in The Cancer Journal, data showed that the RITA
procedure appears to be safe and may significantly relieve intense pain and
back pain-related disabilities associated with metastatic spinal tumors. Pain
and back pain-related disability was reduced and neurological function was
preserved or stabilized with average pain reduction exceeding 70% in the 9 of
10 patients that experienced pain relief. Results of a 12 patient feasibility
study presented at the 2001 annual meeting of the Radiological Society of North
America (RSNA) demonstrated that the RITA procedure may provide a potential
alternative method to address painful metastatic bone lesions that is safe and
offers dramatic pain relief.
Preliminary lung results were presented at the 2001 meetings of the American
Society of Clinical Oncology and RSNA. These results demonstrated that the RITA
system can be successfully used to address pulmonary metastases and may provide
an option for local tumor control in patients for whom surgery is not an
option. Data from a clinical study involving 34 patients with unresectable lung
tumors who were treated with the RITA system was reported at the European
Congress of Radiology in March 2002. For 26 patients who had been followed for
at least three months (mean follow-up was 8.6 months), 95 percent of the
treated tumors were fully ablated and demonstrated no recurrence. There were no
major complications reported.
Breast feasibility data presented at RSNA 2000 reported successful complete
ablation achieved in the first 10 patients studied. No major complications were
reported.
We plan to complete the current clinical investigation of the safety and
effectiveness of the RITA procedure for relief of pain associated with
metastases involving bone in 2002. Clinical investigations for breast and lung
applications will continue into 2003 or beyond.
Competition
The medical device industry is subject to intense competition. Accordingly,
our future success will depend on our ability to meet the clinical needs of
physicians, improve patient outcomes and remain cost-effective for payors.
There are a limited number of treatment alternatives available to patients with
liver cancer. The traditional treatment options include surgery, chemotherapy,
cryosurgery, percutaneous ethanol injections and radiation therapy. We do not
believe any of these treatments are directly competitive with our products, as
none are intended to use heat to ablate liver lesions. Further, these
treatments generally have limited efficacy and/or applicability.
RadioTherapeutics Corporation, which was recently acquired by Boston
Scientific Corporation, and Radionics, a division of Tyco Healthcare, which is
a division of Tyco International, are the two companies whose products compete
directly with ours in the United States and overseas. Both companies offer
systems that include a generator and disposable electrodes and use
radiofrequency energy to ablate soft tissue. However, neither system is
designed to provide physicians with the temperature feedback throughout the
tissue that we believe is important to help ensure successful tissue ablation.
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We believe the principal competitive factors in our markets are:
. improved patient outcomes;
. the publication of favorable peer-reviewed clinical studies;
. acceptance by leading physicians;
. ease of use of our generators and electrode devices;
. sales and marketing capability;
. reimbursement levels to customers;
. regulatory approvals;
. timing and acceptance of product innovation;
. patent protection;
. product quality and reliability; and
. cost effectiveness.
While there are small international companies using radiofrequency
technology to treat cancer, we do not expect these companies to establish a
meaningful presence in our market in the near future. If companies that
currently sell products that utilize radiofrequency energy enter our market,
competition could increase.
Third-Party Reimbursement
Establishing reimbursement for any new technology is a challenge in the
current environment of cost containment and managed care. Currently hospitals
are reimbursed for procedures using our products based on established general
reimbursement codes. Physicians submit a patient case history and data
supporting the applicability of our system to the patient's condition in order
to obtain reimbursement. To date, we believe most of our physician and hospital
customers in the United States have been successful in obtaining substantial
reimbursement from third-party payors of the costs related to our procedure.
The American Medical Association has recently approved specific physician
reimbursement codes for open, laparoscopic and percutaneous liver tumor
ablation procedures that became effective in 2002. While the approval of
specific physician reimbursement codes will not require insurance providers to
reimburse physicians for procedures using our products, it will eliminate the
need for extra supporting documentation and simplify the process for hospitals
and physicians to obtain reimbursement.
Outside the United States, reimbursement procedures and policies are
country-specific. We believe physicians in our international markets can be
successful in obtaining reimbursement for procedures using our products, though
significant effort on the part of the physicians is required. However, in
countries where specific reimbursement codes are strictly required and have not
yet been issued, reimbursement has been denied on that basis. In conjunction
with our distributors, we are pursuing strategies to address reimbursement
issues in international markets.
Product Development
We believe that we have a strong base of proprietary design, development and
manufacturing capabilities. We have particular expertise in the core research
and development areas relevant to the production of new disposable electrode
devices for use in conjunction with our radiofrequency generators. In the
fourth quarter of 2001, we introduced next-generation ablation products,
including our line of Starburst XLi disposable electrodes. We are working on a
number of enhancements to our existing products that we believe will further
improve the ablation process. During the past three fiscal years, we have spent
the following amounts on company-sponsored research and development efforts:
$6.5 million in 2001, $5.6 million in 2000 and $3.9 million in 1999.
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Patents and Proprietary Technology
We believe that a key element of our competitive advantage depends on our
ability to develop and maintain the proprietary aspects of our technology. We
rely on patent protection, as well as a combination of copyright, trade secret
and trademark laws to protect our intellectual property. As of February 28,
2002, we had 46 issued patents worldwide and more than 50 United States and
foreign patent applications pending. The issued patents cover, among other
things, deployable multi-array electrode technology and temperature feedback
technology. Our United States patents expire between 2012 and 2018. Our
European-wide patent expires in 2015 and our Japanese patent expires in 2015.
Government Regulation
Our products are regulated in the United States by the FDA under the Federal
Food, Drug, and Cosmetic Act, or FDC Act, and require clearance of a premarket
notification under Section 510(k) of the FDC Act or approval of a premarket
approval application under Section 515 of the FDC Act by the FDA prior to
commercialization. Material changes or modifications to medical devices,
including changes to product labeling, are also subject to FDA review and
clearance or approval. Under the FDC Act, the FDA regulates, among other
things, the research, clinical testing, manufacturing, safety, effectiveness,
labeling, storage, record keeping, advertising, distribution, sale and
promotion of medical devices in the United States. Non-compliance with
applicable requirements can result in, among other actions, warning letters,
fines, injunctions, civil and criminal penalties against us, our officers, and
our employees, recall or seizure of products, total or partial suspension of
production, failure of the government to grant premarket approval or clearance
for devices, withdrawal of marketing approvals and recommendation that we not
be permitted to enter into government contracts.
Before a new device can be marketed in the United States, the manufacturer
or distributor must obtain FDA clearance of a 510(k) premarket notification
submission or FDA approval of a premarket approval application. It generally
takes three to twelve months from the date of the submission to obtain
clearance of a 510(k) submission, but it may take longer. The FDA is
increasingly requiring a more rigorous demonstration of substantial
equivalence, including clinical trials for some devices.
To date, all of our products have received 510(k) clearances or are exempt
from the 510(k) clearance process. Our initial clearances in the United States
were general in nature and allow our products to be marketed for the ablation
of soft tissue. In March 2000, we received a specific 510(k) clearance from the
FDA for the partial or complete ablation of nonresectable liver lesions. While
we have been successful to date in obtaining regulatory clearance of our
products through the 510(k) notification process, if the FDA concludes that any
product does not meet the requirements for 510(k) clearance, then a premarket
approval would be required and the time required for obtaining regulatory
approval would be significantly lengthened.
Once 510(k) clearance has been received, any products that we manufacture or
distribute are subject to extensive and continuing regulation by the FDA.
Modifications to devices, including changes to product labeling, cleared via
the 510(k) process may require a new 510(k) submission. We have made some
modifications to some of our devices which we believe do not require the filing
of new 510(k) submissions. If the FDA requires us to file a new 510(k)
submission for any device modification, we may be prohibited from marketing the
modified device until the 510(k) is cleared by the FDA.
We are required to register as a medical device manufacturer with the FDA
and with the California Department of Health Services and to list our products
with the FDA. As such, we are subject to inspection by both the FDA and the
California Department of Heath and Safety for compliance with good
manufacturing practices, quality systems regulations, and other applicable
regulations, including labeling and the adulteration and misbranding provisions
of the FDC Act. In addition, our manufacturing processes are required to comply
with good manufacturing practices and quality system regulations which cover
the methods and documentation of the design, testing, production, control,
quality assurance, labeling, packaging and shipping of our products.
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We are also required to comply with medical device reporting regulations
that require us to report to the FDA any incident in which our product may have
caused or contributed to a death or serious injury, or in which our product
malfunctioned and, if the malfunction were to recur, it would be likely to
cause or contribute to a death or serious injury. If the FDA believes that a
company is not in compliance with the law or regulations, it can institute
proceedings to, among other things, detain or seize products, order a recall,
enjoin future violations or distributions and assess civil and criminal
penalties against a company, its officers, and employees. We have filed medical
device reports with the FDA related to skin burns primarily caused by a ground
pad, arterial bleeding caused by improper needle placement and abscesses which
resulted from the large volume of ablated tissue. We believe that none of these
incidents were attributed to a device malfunction.
We are also subject to regulations and product registration requirements in
many of the foreign countries in which we sell our products in the areas of
product standards, packaging requirements, labeling requirements, import
restrictions, tariff regulations, duties and tax requirements. The time
required to obtain marketing approval or clearance required by foreign
countries may be longer or shorter than that required for FDA approval or
clearance, and requirements for licensing a product in a foreign country may
differ significantly from FDA requirements. Either our distributors or we have
received registrations and approvals to market our products in international
markets that include the European Economic Area, Japan, Korea, Canada,
Australia, New Zealand, and other countries. We are seeking or intend to seek,
regulatory registrations or approvals in other international markets.
The European Union has promulgated rules, under the Medical Devices
Directive, or MDD, which require medical devices to bear the "CE mark". The CE
mark is an international symbol of adherence to quality assurance standards. We
obtained MDD certification in December 1996. We received our ISO9001/EN46001
recertification in January 2000 and have instituted all the systems necessary
to meet the Medical Device Directive, thus acquiring the ability to affix the
CE mark to our devices and export our devices to any EC-member country.
Manufacturing
Our manufacturing process for electrodes includes the inspection, assembly,
testing, packaging and external sterilization of finished products. Our
generators are manufactured to our specifications by outside contractors.
We devote significant attention to quality control of our products. We have
established quality systems in conformance with the Quality System Regulation
as mandated by the FDA. Our Mountain View, California facility received ISO
9001/EN46001 recertification in January 2000 and is in conformance with the
European Medical Device Directive for sale of products in Europe.
Employees
As of February 28, 2002, we had 113 full-time employees, including 47 in
sales and marketing, 36 in manufacturing, 16 in research and development and 14
in general and administrative functions. From time to time, we also employ
independent contractors to support our organization.
11
Executive Officers of the Registrant
The following table shows specific information about our executive officers
as of February 28, 2002.
Name Age Position(s)
---- --- -------------------------------------------------------
Barry Cheskin... 41 Chief Executive Officer, President and Director
Donald Stewart.. 46 Chief Financial Officer and Vice President, Finance and
Administration
Daniel Balbierz. 40 Vice President, Research and Development
Vicki Hacker.... 45 Vice President, Clinical Affairs
David Horn...... 34 Vice President, Business Development
Eric Mueninghoff 44 Vice President, Marketing
Trent Reutiman.. 37 Vice President, U.S. Sales
Ronald Steckel.. 48 Senior Vice President, Operations
Kenneth Waters.. 50 Senior Vice President, Global Sales
Barry Cheskin has served as our President and Chief Executive Officer since
May 1997. Prior to joining us, he held various positions at Datascope Corp, a
medical device company. He was President, Collagen Products Division and
Corporate Vice President from May 1994 to April 1997, General Manager,
Vasoseal/Bioplex Division from November 1992 to May 1994, and Director,
Corporate Business Development from April 1992 to November 1992. Mr. Cheskin
holds a B.S. in Mechanical Engineering from Massachusetts Institute of
Technology, an M.S. in Mechanical Engineering from Stanford University, and an
M.B.A. from Columbia University.
Donald Stewart has served as our Vice President, Finance and Administration
and Chief Financial Officer since April 2001. Prior to joining us, Mr. Stewart
served from May 1998 to April 2001 as the Vice President of Finance and
Administration, CFO and Secretary at Abaxis Corporation in Union City,
California. Previously, from March 1997 through February 1998, Mr. Stewart held
the position of Vice President, Finance and Administration for Mimetix, Inc.
Prior to his employment with Mimetix, Inc., he was employed for thirteen years
at SEQUUS Pharmaceuticals, Inc. in a series of positions culminating with the
role of Vice President, Finance and Treasurer. Mr. Stewart holds a B.S. in
Accounting from San Francisco State University and an M.B.A. from Santa Clara
University. He is a Certified Public Accountant.
Daniel Balbierz has served as our Vice President, Research and Development
since April 1998. Prior to joining us, he held the position of Worldwide
Director, Research and Development for the Vascular Access Division of Johnson
& Johnson Medical, Inc., a medical device company, from March 1996 to March
1998. Previously, Mr. Balbierz held the position of Director, Research and
Development at Menlo Care, a medical device company, from June 1987 to March
1996. Mr. Balbierz holds a B.S. in Mechanical Engineering from California
Polytechnic State University.
Vicki Hacker has served as our Vice President, Clinical Affairs since
February 2000. Prior to joining us, she held various positions at Cardima
Corporation, an electro-physiology company, including Director of Clinical
Research from March 1999 to January 2000 and Manager of Clinical Programs from
June 1997 to February 1999. Previously, Ms. Hacker held the position of Senior
Clinical Education/Research Specialist at Heartport, a minimally invasive
cardiac surgery company, from June 1996 to May 1997. From July 1993 to May
1996, she held the position of Associate Director of Clinical Research at
Advanced Bioresearch Associates, a contract research association. Ms. Hacker
holds a B.S. in Nursing from Rush University and an M.S. in Nursing and
Administration from San Jose State University.
12
David Horn has served as our Vice President, Business Development since
September 2001. From February 2000 through November 2000, Mr. Horn held the
position of Vice President, Corporate Development for Ventro Corporation. From
December 1999 through February 2000, he served as Vice President in the
Corporate Finance Department of Morgan Stanley Dean Witter & Co., a financial
services corporation. From July 1995 through November 1999, he held the
position of Associate in the Corporate Finance Department of Morgan Stanley
Dean Witter & Co. Mr. Horn holds an A.B. in Political Economy from Princeton
University and an M.B.A. from Stanford University.
Eric Mueninghoff has served as our Vice President, Marketing since March
2001. From February 2000 to February 2001, he served as Director of Global
Marketing. From January 1999 to January 2000, Mr. Mueninghoff served as
Director of United States Sales. Mr. Mueninghoff joined RITA as National Sales
Manager in September 1997. Prior to joining us, Mr. Mueninghoff held the
position of National Sales Manager for Aria Technologies, a fiberoptics
company, from January 1997 to September 1997. Previously, he held the position
of Executive Territory Manager for the Chiron Vision Corporation, an ophthalmic
device company, from September 1995 to January 1997. Mr. Mueninghoff holds a
B.S. from Illinois State University.
Trent Reutiman has served as our Vice President of U.S. Sales since December
2001. From January 2001 to December 2001, he served as Director of U.S. Sales
and from March 2000 to January 2001 he served as a regional sales manager.
Prior to joining us, Mr. Reutiman served from March 1998 through March 2000 as
a district sales manager with the Cardio Thoracic Systems Division of Guidant
Corporation. From October 1996 through February 1998 he was a sales
representative for Johnson and Johnson's Cordis division. Mr. Reutiman holds a
B.S. in Business Administration from Colorado State University and an M.B.A.
from the University of California, Irvine.
Ronald Steckel has served as our Vice President, Operations since June 1998
and was promoted to Senior Vice President, Operations in January 2001. Prior to
joining us, Mr. Steckel held various positions at Metra Biosystems, Inc., a
medical diagnostics company, including Senior Vice President from July 1996 to
June 1998, Vice President, Operations from February 1992 to June 1996 and a
consultant from July 1991 to February 1992. Mr. Steckel holds a B.S. in Biology
from Blackburn University and an M.B.A. from Lake Forest College.
Kenneth Waters has served as our Senior Vice President, Global Sales since
November 2001. From 1993 through November 2001, Mr. Waters held the position of
Vice President of Global Sales for the Cardiac Assist Division of Datascope
Corporation. Previously, he held other positions with Datascope Corporation,
including National Sales Manager, U.S. and Director of Sales, U.S. Mr. Waters
holds a B.S. in Management from Jacksonville State University.
Item 2. Properties.
We are headquartered in Mountain View, California, where we lease one
building with approximately 18,000 square feet of office, research and
development and manufacturing space. The lease is noncancellable and expires in
August 2004. We believe the facility is suitable and adequate to meet our
current or foreseeable requirements through 2002 and that additional space will
be available at commercially reasonable terms to meet future growth
requirements. See also Note 5 in the "Notes to Financial Statements" contained
elsewhere in this Form 10-K.
Item 3. Legal Proceedings.
We are not currently subject to any material legal proceedings, other than
the patent disputes described in "Risk Factors--We are currently involved in a
patent interference action and a patent opposition action involving
RadioTherapeutics Corporation, and if we do not prevail in these actions, we
may be unable to sell the RITA System." The patent interference proceeding is
pending before the Board of Patent Appeals and
13
Interferences of the United States Patent and Trademark Office. On July 16,
1999 the United States Patent and Trademark Office declared interference
between a claim of one of our issued patents and claims of a patent application
controlled by RadioTherapeutics Corporation. The principal parties in the
proceeding are RadioTherapeutics and RITA. The factual basis underlying the
claim is the determination by the commissioner of the United States Patent and
Trademark Office that our patent and the RadioTherapeutics patent application
interfere. In the interference proceeding, RadioTherapeutics seeks to
invalidate our patent claim and to establish the patentability of the claims in
their patent application. We seek to maintain the priority of our patent claim.
On February 26, 2001, the USPTO issued a decision on preliminary motions filed
in the patent interference proceeding. The decision found that one of the
claims in our United States Patent No. 5,536,267 (claim no. 32) is invalid. We
expect to receive final confirmation of that decision later this year. The
European opposition is pending before the European Patent Office and was
instituted on March 2, 2000. The principal parties are RadioTherapeutics and
RITA. The factual basis underlying the claim is the allegation by
RadioTherapeutics that our European patent is not valid. In the opposition,
RadioTherapeutics seeks to have our patent declared invalid and to have our
patent cancelled. We are defending our patent and seek to defend it as issued.
On February 7, 2002, the European Patent Office determined that we are entitled
to European Patent No. 0777445 which covers radiofrequency ablation technology.
The European Patent Office approved 27 claims, despite the opposition
proceeding by RadioTherapeutics. In addition to these patent proceedings, we
may from time to time become a party to various legal proceedings arising in
the ordinary course of our business.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Our common stock is traded on the Nasdaq National Market under the symbol
"RITA". We commenced trading on July 27, 2000. The following table shows the
high and low closing sales prices of our common stock by quarter for 2000 and
2001 as reported by the Nasdaq National Market:
HIGH LOW
------ -----
Year ended December 31, 2000.................
Third quarter............................. $14.38 $8.88
Fourth quarter............................ $12.38 $5.00
Year ended December 31, 2001.................
First quarter............................. $ 9.50 $2.81
Second quarter............................ $ 5.44 $3.38
Third quarter............................. $ 5.41 $2.66
Fourth quarter............................ $ 6.67 $2.81
Year ended December 31, 2002.................
First quarter (through February 28, 2002). $ 6.91 $5.41
On February 28, 2002, the last reported sales price of our common stock on
the Nasdaq National Market was $6.11. As of February 28, 2002, there were 111
holders of our common stock. This does not include the number of persons whose
stock is in the nominee or "street name" accounts through brokers. The market
price of our common stock has been and may continue to be subject to wide
fluctuations in response to a number of events and factors, such as quarterly
variations in our operating results, announcements of technological innovations
or new products by us or our competitors, changes in financial estimates and
recommendations by securities analysts, the operating and stock performance of
other companies that investors may deem comparable to us, and news reports
relating to trends in our markets. These fluctuations, as well as general
economic and market conditions, may adversely affect the market price for our
common stock.
No dividends have been declared on our common stock. We currently intend to
retain any future earnings to fund the development and growth of our business.
It is not expected that any dividends will be declared on our capital stock in
the foreseeable future.
In December 2001, we issued a warrant to purchase 25,000 shares of our
common stock in connection with a patent license. In October 2001, we issued a
warrant to purchase 25,000 shares of common stock in connection with a
severance agreement. Consideration for these warrants was a nominal amount of
cash plus the execution of the related agreements. The issuances were deemed to
be exempt from registration under the Securities Act in reliance upon Section
4(2) thereof as transactions by an issuer not involving any public offering.
In the year ending December 31, 2000, we issued 412,447 shares of
unregistered common stock to our employees pursuant to the exercise of stock
options under our 1994 incentive stock plan and our 2000 stock plan. These
options were exercised at a weighted average exercise price of $1.14 per share.
These issuances were made in reliance upon Rule 701 promulgated under the
Securities Act.
15
On July 26, 2000, we completed our initial public offering of 3,600,000
common shares at a price of $12.00 per share, raising approximately $39.0
million net of underwriting discounts, commissions and other offering costs
(see also Note 6 in the "Notes to the Financial Statements" contained elsewhere
in this Form 10-K). The managing underwriters were Salomon Smith Barney and
Robertson Stephens. As of December 31, 2001, we have fully used the proceeds of
the offering to expand sales, marketing, physician and patient awareness
programs, to continue product development and clinical research programs, to
repay debt and to fund general corporate purposes including working capital, as
follows:
Approximate Dollar Amount
Use (in millions)
------------------------------------------------------------------------------
Permanent working capital $ 5.0
------------------------------------------------------------------------------
Repayment of term loans and other debt $ 4.6
------------------------------------------------------------------------------
Sales, marketing, research and clinical programs and
general corporate purposes $29.4
------------------------------------------------------------------------------
TOTAL $39.0
16
Item 6. Selected Financial Data.
You should read the following selected financial data in conjunction with
our financial statements and related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" appearing elsewhere
in this Form 10-K. The annual data presented below is derived from our audited
financial statements. Our audited statement of operations for the years ended
December 31, 2001, 2000 and 1999 and our audited balance sheet at December 31,
2001 and 2000 are presented elsewhere in this Form 10-K. The unaudited
information provided below is in thousands, except for per share data.
Years ended December 31,
------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
Statement of Operations Data:
Sales............................................. $ 14,791 $ 10,010 $ 4,629 $ 1,137 $ 220
Cost of goods sold................................ 6,132 6,048 2,994 1,523 589
-------- -------- -------- -------- --------
Gross profit (loss)............................ 8,659 3,962 1,635 (386) (369)
-------- -------- -------- -------- --------
Operating expenses:
Research and development....................... 6,489 5,615 3,931 2,729 2,486
Selling, general and administrative............ 16,646 12,052 5,452 3,606 2,829
-------- -------- -------- -------- --------
Total operating expenses................... 23,135 17,667 9,383 6,335 5,315
-------- -------- -------- -------- --------
Loss from operations.............................. (14,476) (13,705) (7,748) (6,721) (5,684)
Interest and other income (expense), net.......... 1,516 898 238 (28) (176)
-------- -------- -------- -------- --------
Net loss.......................................... $(12,960) $(12,807) $ (7,510) $ (6,749) $ (5,860)
======== ======== ======== ======== ========
Net loss per share, basic and diluted............. $ (0.90) $ (1.99) $ (9.33) $ (10.10) $ (11.02)
======== ======== ======== ======== ========
Shares used in computing net loss per share, basic
and diluted..................................... 14,353 6,440 805 668 532
December 31,
------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
Balance Sheet Data:
Cash, cash equivalents and marketable securities.. $ 19,184 $ 40,057 $ 12,153 $ 7,644 $ 147
Working capital................................... 25,478 41,512 12,437 7,560 (2,276)
Total assets...................................... 35,834 46,270 15,705 9,009 1,082
Long-term obligations, net of current portion..... -- 180 1,854 -- 17
Convertible preferred stock and preferred stock
warrants........................................ -- -- 38,516 28,337 12,492
Common stock and additional paid-in capital....... 88,474 88,435 3,652 165 56
Total stockholders equity (deficit)............... 32,145 42,647 (26,991) (20,510) (14,275)
17
Quarterly Results of Operations:
The following table sets forth selected items from our statements of
operations for each of the eight quarters ended December 31, 2001. This data
has been derived from unaudited financial statements that, in the opinion of
our management, include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of such information when read in
conjunction with our annual audited financial statements and notes thereto
appearing elsewhere in this Form 10-K. The operating results for any quarter
are not necessarily indicative of results for any future period.
Quarter Ended
------------------------------------------------------------------------
Dec. 31, Sept. 30, June 30, Mar. 31, Dec. 31, Sept. 30, June 30, Mar. 31,
2001 2001 2001 2001 2000 2000 2000 2000
-------- --------- -------- -------- -------- --------- -------- --------
Net Sales................... $ 4,011 $ 3,707 $ 3,769 $ 3,304 $ 3,030 $ 2,712 $ 2,427 $ 1,841
Gross Profit................ 2,790 2,235 2,099 1,535 1,279 1,090 933 659
------- ------- ------- ------- ------- ------- ------- -------
Net Loss.................... $(3,761) $(3,084) $(2,993) $(3,122) $(3,067) $(2,956) $(3,207) $(3,578)
======= ======= ======= ======= ======= ======= ======= =======
Net Loss per Share.......... $ (0.26) $ (0.21) $ (0.21) $ (0.22) $ (0.22) $ (0.31) $ (2.79) $ (3.52)
======= ======= ======= ======= ======= ======= ======= =======
Shares used in computing net
loss per share, basic and
diluted................... 14,514 14,406 14,320 14,167 13,869 9,607 1,150 1,017
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Management's Discussion and Analysis of Financial Condition and Results
of Operations and other parts of this Form 10-K contain forward-looking
statements that involve risks and uncertainties. Words such as "anticipates",
"expects", "intends", "plans", "believes", "seeks", "estimates", and similar
expressions identify such forward-looking statements. These statements are not
guarantees of future performance and are subject to risks and uncertainties
that could cause actual results to differ materially from those expressed or
forecasted. Factors that might cause such a difference include, but are not
limited to, those discussed in the section entitled "Factors That May Affect
Future Results" and those appearing elsewhere in this Form 10-K. Readers are
cautioned not to place undue reliance on these forward-looking statements that
reflect management's analysis only as of the date hereof. We assume no
obligation to update these forward-looking statements to reflect actual results
or changes in factors or assumptions affecting such forward-looking statements.
Business Overview and Discussion of Known Trends
We develop, manufacture and market minimally invasive products that use
radiofrequency energy to treat patients with solid cancerous or benign tumors.
From inception in 1994 through 1996, our operations consisted primarily of
various start-up activities, including development of technologies central to
our business, recruiting personnel and raising capital. In 1997, we began
commercial product shipments. In 2001, we commercially launched our StarBurst
XLi family of disposable devices and significantly expanded our direct domestic
sales organization and our international distribution network.
Our products are sold in the United States through our direct sales force
and internationally through distribution partners. For the year ended December
31, 2001, sales in the United States accounted for 54% of our total sales while
sales in our international markets accounted for 46% of our total sales. We
expect domestic sales to account for an increasing percentage of total sales in
future years due to our significant investment in our domestic sales force and
because, at least for 2002, our premium-priced Starburst XLi family of
disposable needles will only be distributed in the United States. Conversely,
we expect reimbursement issues in Europe and Japan to limit sales growth in
these regions for the next several years. However, our international operations
will continue to represent a significant, if decreasing, portion of our revenue
because of the high incidence of primary liver cancer in Asian and European
markets.
18
All of our revenue is derived from the sale of our disposable devices and
radiofrequency generators. For the year ended December 31, 2001, 78% of our
sales were derived from our disposable devices and 22% were derived from the
sale of our generators. We will continue to focus on expanding our base of
customer accounts and on increasing usage of our disposable products in our
established accounts. As a result, revenue from our higher-margin disposable
devices should continue to grow faster than revenue from our generators.
To date, essentially all of our revenue has come from products sold in the
treatment of cancerous liver tumors. In 2002, we expect some additional revenue
in the fourth quarter to come from the use of the RITA system sold for the
treatment of patients with metastatic bone tumors, and nominal revenue at the
end of 2002 from sales for the treatment of unresectable lung tumors. We are
conducting research and clinical trials in other organs that may lead to
additional sources of revenue in the years beyond 2002.
Our manufacturing costs consist of raw materials, including generators
produced for us by third-party suppliers, labor to produce our disposable
devices and to inspect incoming, in-process and finished goods, sterilization
performed by an outside service provider and general overhead expenses. Gross
margins are affected by production volumes, average selling prices, the sales
mix of higher-margin disposable devices versus generators and the mix of
domestic direct sales versus international sales, which provide for standard
distributor discounts. Our gross margin improved in 2001, increasing to 59%
from 40% in 2000, in response to the increasing percentages of domestic
business and disposable products in our sales mix and lower unit costs driven
by higher production volumes. We expect gross margins to continue to improve in
the near term primarily as a result of continued improvements in our sales mix
and cost factors and also due to the growing acceptance of our premium-priced
Starburst XLi line of disposable devices.
For the year ended December 31, 2001, 28% of our operating expenses were
related to research and development activities, down from 32% in 2000. We
expect our research and development activities to continue to grow more slowly
than sales and marketing activities, at least through 2002, as we commit
significantly more resources to market development and business expansion
efforts. Selling, general and administrative activities represented 72% of our
operating expenses for the year, up from 68% in 2000. This increase resulted
from investments in the expansion of our domestic sales force and international
distribution support activities as well as physician training and patient
awareness programs. Also, because our collection periods in Europe have grown
longer as a result of difficult economic conditions, we increased our allowance
for uncollectible accounts to 11% of gross trade receivables as of December 31,
2001, from 4% at December 31, 2000. This increase further affected growth in
administrative expense. While our investments in market growth and business
development will continue to grow, we believe the deterioration we experienced
in our European collections in 2001 will begin to stabilize as the global
economy improves and that the need to increase our allowance for uncollectible
accounts will moderate.
Our working capital decreased to $25.5 million at December 31, 2001, from
$41.5 million at December 31, 2000, primarily due to cash used to fund
operations. However, our investments in accounts receivable and inventory
increased during the year. Accounts receivable, net of reserves, were $5.1
million at December 31, 2001, up from $2.4 million at December 31, 2000. This
increase was due to our increasing sales volume and to a significant
lengthening of collection cycle with our European distributors. Inventory, net
of reserves, was $3.6 million at December 31, 2001, up from $1.6 million at
December 31, 2000. Inventory growth was driven by increasing sales volume and
temporary investments intended to support the market introduction of new
products.
In connection with grants of stock options to employees and non-employees,
we record deferred stock-based compensation as a component of stockholders'
equity. This stock-based compensation is amortized as charges to operations
over the vesting periods of the options. We recorded amortization of deferred
compensation of $1.4 million for the year ended December 31, 2001. We expect to
record additional amortization expense for deferred compensation, in
diminishing amounts, through 2004, at which point our existing deferred
stock-base compensation will be fully amortized.
19
We incurred net losses of $13.0 million for the year ended December 31,
2001. As of December 31, 2001, we had an accumulated deficit of $54.4 million.
Due to the high costs associated with continued research and development
programs, expanded clinical research programs and increased sales and marketing
efforts, we expect to incur net losses for the full year 2002, but losses
should diminish through the first three quarters of the year, and we expect to
be modestly profitable in the fourth quarter of 2002. Profitability beyond 2002
will depend on our success in expanding product usage in our current market and
in developing new markets. To the extent current or new markets do not
materialize in accordance with our expectations, our sales and profitability
could be lower than expected and we may be unable to achieve or sustain
profitability.
We are currently involved in patent proceedings and may become a party to
additional patent or product liability proceedings. The costs of such lawsuits
or proceedings may be material and could affect our earnings and financial
position. An adverse outcome in a patent lawsuit could require us to cease
sales of affected products or to pay royalties and/or license fees, which could
harm our results of operations.
Critical Accounting Policies
We believe the following accounting policies have been critical in the
preparation of our financial statements because they involve a high degree of
judgment and complexity. We believe users of our financial statements,
including potential and current investors, will find an explanation of these
policies important to understanding our discussions of financial condition,
results of operations and liquidity. A more extensive review of all accounting
policies considered to be significant in the preparation of our financial
statements appears in the Notes to the Financial Statements included elsewhere
in this Form 10-K.
Trade accounts receivable and allowance for doubtful accounts: We extend
credit to our customers, who are primarily private companies in the United
States, Europe and Asia. We perform ongoing credit evaluations of our
customers' financial condition and past transaction credit-worthiness and
generally require no collateral. We maintain an allowance for doubtful accounts
receivable based on our assessment of the likelihood of collection of
individual accounts. This allowance may prove to be inadequate if collections
fail to meet current estimates, which could occur as a result of general
economic conditions or the insolvency of specific key customers.
Inventories and inventory reserves: Inventories are stated at the lower of
cost (determined on a first-in, first-out basis) or market. We maintain a
reserve for obsolete, unmarketable or excess product based on assumptions
regarding future demand or market conditions. We may be required to make
further provisions to our reserve if market conditions prove less favorable
than our current expectations, or if the introduction of new products renders
existing products obsolete.
Litigation costs: In August 2001, we filed a complaint in the United States
District Court for the Northern District of California against
RadioTherapeutics Corporation. As discussed in Note 5 of our consolidated
financial statements appearing elsewhere in this Form 10K, the complaint
alleges that RadioTherapeutics' radiofrequency ablation products infringe six
of our patents. The litigation costs thereby incurred in defense of our
patents, approximately $332,000 as of December 31, 2001, have been capitalized.
Amortization of this asset has been matched to the remaining life of the six
patents, approximately 11 years. Although we expect a favorable outcome in this
matter, an unsuccessful outcome would require an immediate charge to earnings
of any remaining unamortized costs. It is probable that additional litigation
costs will be capitalized in future periods.
Contingencies: In addition to the complaint described in the preceding
paragraph, we are involved in a patent interference proceeding in the United
States with RadioTherapeutics Corporation in which the validity of one of our
patents has been called into question. Although we believe we have meritorious
defenses, we could be prevented from selling the RITA system or be required to
pay license fees and/or royalties on past and future product sales if we do not
prevail in this interference proceeding. Further, we are involved in a patent
opposition currently pending before the European Patent Office. The principal
parties in this opposition are RadioTherapeutics and RITA. RadioTherapeutics
seeks to have our only European patent declared invalid. In
20
February 2002, the European Patent Office determined that we were entitled to
this patent, European Patent No. 0777445, but appeals of this decision are
likely and a final decision is not expected in this opposition proceeding for
several years. If we do not prevail in the opposition proceeding, we could lose
our only currently issued patent in Europe.
Both the interference proceeding in the United States and the European
opposition proceeding are discussed in Note 5 to our consolidated financial
statements contained elsewhere in this form Form 10-K. As of December 31, 2001,
it is not possible to estimate additional probable costs for the resolution of
these claims. Although we do not currently believe these proceedings will have
a material adverse effect on our consolidated financial position, it is
possible that future results of operations could be materially affected by
rulings that are unfavorable to us.
Revenue recognition: Revenue is recognized upon receipt of a customer
purchase order and subsequent product shipment provided no significant
obligations remain and collection of the associated receivable is deemed
probable. This policy is applied to all of our customers, including our
distributors, who have no price protection and no return rights on product
purchased. Should changes in conditions or the status of obligations cause us
to determine that our criteria are not met for certain future transactions,
revenue recognized for any reporting period could be adversely affected. We do
not generally engage in "bundling" transactions that would call for the
deferral of revenue. Through December 31, 2001, all of our billings have been
denominated in US dollars, although we expect relatively minor billings in
foreign currencies in future periods.
Results of Operations
The following table sets forth the percentage of net revenue represented by
certain items in our Statements of Operations for the years ended December 31,
2001, 2000 and 1999 respectively:
Years Ended December 31,
----------------------
2001 2000 1999
---- ---- ----
Sales................................... 100% 100% 100%
Cost of goods sold...................... 41% 60% 65%
--- ---- ----
Gross profit......................... 59% 40% 35%
--- ---- ----
Operating expenses:
Research and Development............. 44% 56% 85%
Selling, general and administrative.. 113% 120% 118%
--- ---- ----
Total operating expenses......... 156% 176% 203%
--- ---- ----
Loss from operations.................... (98%) (137%) (167%)
Interest and other income (expense), net 10% 9% 5%
--- ---- ----
Net loss................................ (88%) (128%) (162%)
=== ==== ====
Years Ended December 31, 2001 and 2000
For the year ended December 31, 2001, sales totaled $14.8 million, an
increase of 48% from $10.0 million in 2000. We experienced growth in both
domestic and international markets, with domestic sales increasing by 104% and
international sales increasing by 11% over the previous year. For the year
ended December 31, 2001, domestic sales represented 54% of total revenue, as
compared to 39% in 2000. Sales of our disposable products grew by 73% and
generator sales decreased by 4% compared with 2000 results. Also, for the year
ended December 31, 2001, disposable sales accounted for 78% of total revenue,
up from 67% in 2000. Higher unit shipments of generators and disposables
resulted from increased physician awareness of our technology, a major
expansion of our domestic sales force, increased geographical representation
through the appointment of new international distributors and the launch of our
StarBurst XLi family of disposable devices.
21
Cost of goods sold for the year ended December 31, 2001 was $6.1 million as
compared to $6.0 million in 2000. The growth in cost of goods sold was
attributable primarily to higher material, labor, and overhead costs associated
with increased unit shipments. Included in cost of goods sold was amortization
of deferred stock-based compensation of $558,000, down from $926,000 in 2000.
Excluding the effect of the amortization of deferred stock-based compensation,
gross margins improved to 62% in 2001 from 49% in 2000. The improvement was due
to higher average selling prices of our disposable devises, related to the
launch of our premium-priced five and seven centimeter StarBurst XLi
electrodes, and to the increasing proportions of domestic business and
disposable products in our sales mix. Gross margins also benefited from
manufacturing efficiencies attained through higher volume production of our
disposable devices.
Research and development expenses for the year ended December 31, 2001 were
$6.5 million as compared to $5.6 million in 2000. This increase was due to
expenses associated with the development of our next-generation technology,
increased clinical program spending, and increased spending related to the
growth and protection of our patent portfolio. Amortization of deferred
stock-based compensation was $465,000 for the year, down from $998,000 in 2000.
We expect to continue to make substantial investments in research and
development, although research and development expense may fall in 2002 as most
of the development costs of the new Starburst Xli disposable device have
already been recognized.
Selling, general and administrative expenses for the year ended December 31,
2001 were $16.6 million as compared to $12.1 million in 2000. The increase was
primarily attributable to the major expansion of our domestic sales
organization, additional investments in market development and public
relations, and administrative expenses relating to provisions to our allowance
for uncollectible accounts. Amortization of deferred stock-based compensation
was $349,000 for the year, down from $2,898,000 in 2000. We anticipate that
selling, general and administrative expenses will continue to increase as we
expand our sales organization, invest in marketing and public relations and add
personnel.
Interest income was $1.6 million for the years ended December 31, 2001 and
2000. Although average daily cash balances were higher in 2001 than in 2000,
lower market interest rates resulted in no growth in interest income. Interest
expense for 2001 was $86,000, down from $683,000 in 2000, as a result of
repayment during the year of bank debt, all of which had been eliminated by
June 2001.
Years Ended December 31, 2000 and 1999
For the year ended December 31, 2000, sales totaled $10.0 million, an
increase of 116% from $4.6 million in 1999. We experienced growth in both
domestic and international markets, with domestic sales increasing 136% and
international sales increasing 105% over the previous year. For the year ended
December 31, 2000, domestic sales represented 39% of total revenue, as compared
to 36% in 1999. We experienced growth in sales of our disposable products and
our generators, with disposable product sales increasing 124% and generator
sales increasing 102% over the previous year. For the year ended December 31,
2000, disposable sales accounted for 67% of total revenue, as compared to 64%
in 1999. Higher unit shipments of generators and disposables resulted from
increased physician awareness of our technology, a major expansion of our
domestic sales force, increased geographical representation through the
appointment of new international distributors and the launch of our Model 1500
generator and StarBurst family of disposable devices.
Cost of goods sold for the year ended December 31, 2000 was $6.0 million as
compared to $3.0 million in 1999. The growth in cost of goods sold was
attributable primarily to higher material, labor, and overhead costs associated
with increased unit shipments. Included in cost of goods sold was amortization
of deferred stock-based compensation of $926,000 in the year ended December 31,
2000 as compared to $107,000 in 1999. Excluding the effect of the amortization
of deferred stock-based compensation, gross margins improved to 49% in 2000
from 38% in 1999. The improvement was due in part to an increase in average
selling prices of our disposable devices, related to the launch of our
five-centimeter StarBurst XL electrode. The improvement was
22
also the result of the increase in higher margin disposable devices as a
proportion of total sales. Gross margins also benefited from manufacturing
efficiencies attained through higher volume production of our disposable
devices.
Research and development expenses for the year ended December 31, 2000 were
$5.6 million as compared to $3.9 million in 1999. The expense increase was due
to additional personnel, expenses associated with the development of our
next-generation technology, increased clinical program spending, increased
spending related to the growth and protection of our patent portfolio and
increases in the amortization of deferred stock-based compensation.
Amortization of deferred stock-based compensation was $998,000 for the year
ended December 31, 2000 as compared to $354,000 in 1999.
Selling, general and administrative expenses for the year ended December 31,
2000 were $12.1 million as compared to $5.5 million in 1999. The expense
increase was primarily attributable to the major expansion of our domestic
sales organization, increased administrative expenses due to added personnel to
support our growth in operations, the costs associated with our operation as a
public company and increases in the amortization of deferred stock-based
compensation. For the year ended December 31, 2000, we recorded amortization of
deferred stock-based compensation of $2.9 million as compared to $530,000 in
1999.
Interest income for the year ended December 31, 2000 was $1.6 million as
compared to $446,000 in 1999. The increase in interest income was primarily
attributable to earnings on short-term investments made with cash received from
our initial public offering of common shares completed in the third quarter of
2000. Interest expense for the year ended December 31, 2000 was $683,000 as
compared to $212,000 in 1999. The increase in interest expense for 2000 was
attributable to higher average debt outstanding on the loan and security
agreement entered into in June 1999. During the third quarter of 2000, we
repaid all debt outstanding under our term loans, and during the fourth quarter
of 2000, we repaid $500,000 of borrowings under our revolving credit facility,
bringing our bank debt outstanding to $833,000 at December 31, 2000.
Liquidity and Capital Resources
Prior to August 2000, we financed our operations principally through private
placements of convertible preferred stock, raising approximately $37.9 million
net of expenses. On August 1, 2000, we completed our initial public offering of
3.6 million common shares at a price of $12 per share, raising approximately
$39.0 million net of expenses. All outstanding convertible preferred shares
were converted to common shares at that time. To a lesser extent, we also
financed our operations through equipment financing and other loans (see
below), which totaled $1.3 million in principal outstanding at December 31,
2000 and $0.2 million at December 31, 2001. As of December 31, 2001, we had
$7.3 million of cash and cash equivalents, $11.9 million of marketable
securities, $4.4 million in investments intended for resale and $25.5 million
of working capital.
For the year ended December 31, 2001, net cash used in operating activities
was $14.2 million principally due to our net loss and increases in accounts
receivable and inventory resulting from higher revenues, a lengthened
collection cycle and increased unit shipments. Our investing activities for the
year were limited to the purchase of property and equipment in the amount of
$1.6 million and net purchases or sales of short-term investment instruments.
Net cash used by financing activities for the year was $0.4 million, as
payments on bank debt and lease obligations exceeded the proceeds received from
issuance of common stock.
For the year ended December 31, 2000, net cash used in operating activities
was $8.9 million principally due to our net loss and increases in accounts
receivable and inventory resulting from higher revenues and increased unit
shipments. Our investing activities for the year ended December 31, 2000 were
limited to the purchase of property and equipment in the amount of $856,000 and
net purchases or sales of short-term investment instruments. For the year ended
December 31, 2000, net cash provided by financing activities was $37.6 million,
attributable to our initial public offering of common shares, partially offset
by borrowings and repayment of debt.
23
In June 1999, we entered into a loan and security agreement for a loan
facility of up to $5.0 million. The facility consisted of two term loans of
$1.5 million each and a revolving credit note of up to $2.0 million. As of
December 31, 2000, borrowings under the term loans had been completely repaid
and we had a balance outstanding of $833,000 on the revolving credit note,
bearing interest at 2% over the prime rate. This balance was paid as scheduled
in 2001 and the loan facility was cancelled. We have also, from time to time,
financed equipment through capital and operating leases. As of December 31,
2001, our future minimum payments due under capital and operating leases are as
follows:
Future minimum capital lease payments
-------------------------------------
Payments due in 2002........................................ $ 204
Less imputed interest (including warrants).................. (12)
------
Present value of future minimum capital lease payments...... $ 192
======
Future minimum operating lease payments
---------------------------------------
2002........................................................ $ 530
2003........................................................ 533
2004........................................................ 356
------
Total of future minimum operating lease payments............ $1,419
======
Our capital requirements depend on numerous factors including our research
and development expenditures, expenses related to selling, general and
administrative operations and working capital to support business growth.
Although it is difficult for us to predict future liquidity requirements with
certainty, we believe that our current cash and cash equivalents will satisfy
our cash requirements for at least the next 18 months. During or after this
period, if cash generated by operations is insufficient to satisfy our
liquidity requirements, we may need to sell additional equity or debt
securities or obtain an additional credit facility. There can be no assurance
that additional financing will be available to us or, if available, that such
financing will be available on terms favorable to the company and our
stockholders.
Income Taxes
As of December 31, 2001, we had federal net operating loss carryforwards of
approximately $42.7 million and state net operating loss carryforwards of
approximately $18.0 million, available to offset future regular taxable income.
We have fully reserved our deferred tax assets, however, because realization of
favorable tax assets in future returns is very uncertain. The federal net
operating loss carryforwards will expire between 2010 and 2021, and the state
net operating loss carryforwards will expire between 2002 and 2006, if not
utilized. The Tax Reform Act of 1986 limits the use of net operating loss and
tax credit carryforwards in certain situations where changes occur in the stock
ownership of the company, and our utilization of our carryforwards could be
restricted. See also Note 8 to "Notes to Financial Statements" appearing
elsewhere in this Form 10-K.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting and Standards Board ("FASB") issued
Statements of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations," and No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets." SFAS 141 requires that all business combinations initiated after June
20, 2001 be accounted for under the purchase method. Use of the
pooling-of-interests method is no longer permitted. SFAS 142 requires that
goodwill no longer be amortized to earnings, but instead be reviewed for
impairment upon initial adoption of the Statement and on an annual basis going
forward. The amortization of goodwill will cease upon adoption of SFAS 142. The
provisions of SFAS 142 will be effective for fiscal years beginning after
December 15, 2001. The Company is required to adopt SFAS 142 in the first
quarter of 2002. We believe that adoption of these standards will have no
impact on our financial statements.
24
In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets," which is effective for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal periods. This
Statement supersedes FASB Statement No. 121 and APB 30, however, this Statement
retains the requirement of Opinion 30 to report discontinued operations
separately from continuing operations and extends that reporting to a component
of an entity that either has been disposed of (by sale, by abandonment, or in a
distribution to owners) or is classified as held for sale. This Statement
addresses financial accounting and reporting for the impairment of certain
long-lived assets and for long-lived assets to be disposed of. Management does
not expect the adoption of SFAS No. 144 to have a material impact on the
Company's financial position and results of operations.
In May 2000, the Emerging Issues Task Force (EITF) issued EITF Issue No.
00-14, "Accounting for Certain Sales Incentives," addressing the recognition,
measurement and income statement classification of sales incentives that a
vendor voluntarily offers to its customers, without charge, and which customers
may then use in, or exercise as a result of, a single exchange transaction.
Sales incentives falling within the scope of EITF Issue No. 00-14 include
offers that customers may use to receive a reduction in the price of products
or services at the point of sale. In June 2001, the EITF issued EITF Issue No.
00-25, "Vendor Income Statement Characterization of Consideration Paid to a
Reseller of the Vendor's Products," addressing whether consideration from a
vendor to a reseller is (a) an adjustment to the selling prices of the vendor's
products and therefore a deduction from revenue when recognized in the vendor's
statement of operations or (b) a cost incurred by the vendor for assets or
services received from the reseller and therefore a cost or expense when
recognized in the vendor's statement of operations. In September 2001, the EITF
issued Issue No. 01-09, "Accounting for Consideration Given by a Vendor to a
Customer or a Reseller of the Vendor's Products," which is a codification of
EITF Issues No. 00-14, No. 00-25 and also No. 00-22, "Accounting for 'Points'
and Certain Other Time or Volume-Based Sales Incentive Offers and Offers for
Free Products or Services to be Delivered in the Future." The requirements of
EITF Issue No. 01-09, as with the preceding Issues No. 00-14, No. 00-22 and No.
00-25, became effective for annual or interim financial statements dated after
December 15, 2001, and include a requirement to reclassify the financial
statements of prior periods as necessary to conform with current income
statement display standards. No material impact on our financial statements has
resulted from the adoption of the above EITF Issues.
Factors That May Affect Future Results
In addition to the other information in this report, the following factors
should be considered carefully in evaluating the Company's business and
prospects.
Due to our dependence on the RITA system, failure to achieve market acceptance
in a timely manner could harm our business.
Because all of our revenue comes from the sale of the RITA system, our
financial performance will depend upon physician adoption and patient awareness
of this system. If we are unable to convince physicians to use the RITA system,
we may not be able to generate revenues because we do not have alternative
products.
We are currently involved in a patent interference action and a patent
opposition action involving RadioTherapeutics Corporation, and if we do not
prevail in these actions, we may be unable to sell the RITA system.
In July 1999, the United States Patent and Trademark Office declared an
interference involving us, which was provoked by RadioTherapeutics Corporation,
a competitor of ours, in which the validity of a patent claim previously issued
to us is being called into question. The claim being questioned is one of a
number of issued patent claims that cover the curvature of the array at the tip
of our disposable devices. In February 2001, the USPTO issued a decision on
preliminary motions filed in the patent interference proceeding. The decision
found that one of the claims in our United States Patent No. 5,536,267 (claim
no. 32) is invalid. We expect to receive final confirmation of that decision
later this year. In the event that the decision is confirmed, we plan to file a
25
motion in a United States District Court requesting review of the decision.
Final determination of the patent interference proceeding may take several
years. If the final determination of the United States District Court results
in the issuance of patent rights related to the claim to RadioTherapeutics and
we were unable to obtain a license to use the relevant patent or successfully
modify our disposable device, we could be unable to sell our system and our
business could suffer.
In March 2000, RadioTherapeutics Corporation filed an opposition to our
European Patent No. 0777445. This patent also covers the curvature of the array
at the tip of our disposable devices. In this opposition, the validity of our
issued patent is being questioned. In February 2002, the European Patent Office
determined that we were entitled to European Patent No. 0777445. A final
decision is not expected in this proceeding for several years. If we do not
prevail in the opposition proceeding, we could lose our only currently issued
patent in Europe.
We have a history of losses, anticipate significant increases in our operating
expenses over the next several years and may never achieve profitability.
We anticipate that our operating expenses will increase substantially in
absolute dollars for the foreseeable future as we expand our sales and
marketing, manufacturing, clinical research and product development efforts. In
addition, we have charged operating expense to increase our allowance for
uncollectible accounts in connection with lengthening collection periods for
our accounts in Europe. To become profitable, we must continue to increase our
sales. If sales do not continue to grow, we may not be able to achieve or
maintain profitability in the future. In particular, we incurred net losses of
$13.0 million in 2001, $12.8 million in 2000 and $7.5 million in 1999. At
December 31, 2001, we had an accumulated deficit of approximately $54.4 million.
Because we face significant competition from companies with greater resources
than we have, we may be unable to compete effectively.
The market for our products is intensely competitive, subject to rapid
change and significantly affected by new product introductions and other market
activities of industry participants.
We compete directly with two companies in the domestic and international
markets: RadioTherapeutics Corporation, a division of Boston Scientific
Corporation, and Radionics, Inc., a division of Tyco Healthcare, which is a
division of Tyco International. Boston Scientific Corporation and Tyco
International are publicly traded companies with substantially greater
resources than we have. Both RadioTherapeutics and Radionics sell products that
use radiofrequency energy to ablate soft tissue.
Alternative therapies could prove to be superior to the RITA system, and
physician adoption could be negatively affected.
In addition to competing against other companies offering products that use
radiofrequency energy to ablate soft tissue, we also compete against companies
developing, manufacturing and marketing alternative therapies that address both
cancerous and benign tumors. If these alternative therapies prove to offer
treatment options that are superior to our system, physician adoption of our
products could be negatively affected and our revenues could decline.
We currently lack long-term data regarding the safety and efficacy of our
products and may find that long-term data does not support our short-term
clinical results.
Our products are supported by an average clinical follow-up of between five
and 14 months in published clinical reports. If longer-term studies fail to
confirm the effectiveness of our products, our sales could decline. If
longer-term patient follow-up or clinical studies indicate that our procedures
cause unexpected, serious complications or other unforeseen negative effects,
we could be subject to significant liability. Further, because some of our data
has been produced in studies that were not randomized and/or included small
patient populations, our clinical data may not be reproduced in wider patient
populations.
26
If we are unable to protect our intellectual property rights, we may lose
market share to a competitor and our business could suffer.
Our success depends significantly on our ability to protect our proprietary
rights to the technologies used in our products, and yet we may be unable to do
so. A number of companies in our market, as well as universities and research
institutions, have issued patents and have filed patent applications that
relate to the use of radiofrequency energy to ablate soft tissue. Our pending
United States and foreign patent applications may not issue or may issue and be
subsequently successfully challenged by others and invalidated. In addition,
our pending patent applications include claims to material aspects of our
products that are not currently protected by issued patents. Both the patent
application process and the process of managing patent disputes can be time
consuming and expensive.
In the event a competitor infringes upon our patent or other intellectual
property rights, enforcing those rights may be difficult and time consuming.
Even if successful, litigation to enforce our intellectual property rights or
to defend our patents against challenge could be extensive and time consuming
and could divert our management's attention. We may not have sufficient
resources to enforce our intellectual property rights or to defend our patents
against a challenge. In addition, confidentiality agreements executed by our
employees, consultants and advisors may not be enforceable or may not provide
meaningful protection for our trade secrets or other proprietary information in
the event of unauthorized use or disclosure. If we are unable to protect our
intellectual property rights we could lose market share to a competitor and our
business could suffer.
If we are sued for patent infringement, we could be prevented from selling our
products and our business could suffer.
We are aware of the existence of patents held by competitors in our market,
which could result in a patent lawsuit against us. In the event that we are
subject to a patent infringement lawsuit and if the relevant patents were
upheld as valid and enforceable and we were found to infringe, we could be
prevented from selling our products unless we could obtain a license or were
able to redesign the product to avoid infringement. If we were unable to obtain
a license or successfully redesign our system, we may be prevented from selling
our system and our business could suffer.
Our dependence on international revenues, which account for a significant
portion of our revenues, could harm our business.
Because our future profitability will depend in part on our ability to grow
product sales in international markets, we are exposed to risks specific to
business operations outside the United States. These risks include:
. the challenge of managing international sales without direct access to the
end customer;
. the risk of inventory build-up by our distributors which could negatively
impact sales in future periods;
. obtaining reimbursement for procedures using our devices in some foreign
markets;
. the burden of complying with complex and changing foreign regulatory
requirements;
. longer accounts receivable collection time;
. significant currency fluctuations, which could cause our distributors to
reduce the number of products they purchase from us because the cost of
our products to them could increase relative to the price they could
charge their customers;
. reduced protection of intellectual property rights in some foreign
countries; and
. contractual provisions governed by foreign laws.
27
We are substantially dependent on two distributors in our international
markets, and if we lose either distributor or if either distributor
significantly reduces their product demand, our international and total
revenues could decline.
We are substantially dependent on a limited number of significant
distributors in our international markets, and if we lose these distributors
and fail to attract additional distributors, our international revenues could
decline. ITX Corporation, formerly known as Nissho Iwai Corporation, is our
primary distributor in Asia. It accounted for 31 percent of our international
revenues for the year ended December 31, 2001 and 48 percent of our
international revenues in 2000. M.D.H. s.r.l. Forniture Ospedaliere, our
distributor in Italy, accounted for 17 percent of our international revenues
for the year ended December 31, 2001 and 17 percent of our international
revenues for 2000. Because international revenues accounted for 46 percent of
our total revenues for the year ended December 31, 2001 and these two
distributors represented 48 percent of that total, the loss of either
distributor or a significant decrease in unit purchases by either distributor
could cause revenues to decline substantially. If we are unable to attract
additional international distributors, our international revenues may not grow.
Our relationships with third-party distributors could negatively affect our
sales.
We sell our products in international markets through third-party
distributors over whom we have limited control, and, if they fail to adequately
support our products, our sales could decline. If our distributors or we
terminate our existing agreements, finding companies to replace them could be
an expensive and time-consuming process and sales could decrease during any
transition period.
In addition, we are aware that some of our international distributors have
built up inventory of our disposable devices. As a result, future sales of our
newer generation disposable devices by these distributors could be negatively
impacted. In addition, while these distributors have no price protection and no
right of return relating to purchased products, if we permit the return of any
of these products, we will have to adjust our revenues relating to these
products.
If customers in markets outside the United States experience difficulty
obtaining reimbursement for procedures using our products, international sales
could decline.
Certain of the markets outside the United States in which we sell our
products require that specific reimbursement codes be obtained before
reimbursement for procedures using our products can be approved. As a result,
in countries where specific reimbursement codes are strictly required and have
not yet been issued, reimbursement has been denied on that basis. ITX, our
distributor in Japan, is conducting studies that are necessary to obtain
reimbursement coverage in Japan, but to date has not yet received this
approval. If we are unable to either obtain the required reimbursement codes or
develop an effective strategy to resolve the reimbursement issue, physicians
may be unwilling to purchase our products which could negatively impact our
international revenues.
If third-party payors do not reimburse health care providers for use of the
RITA system, purchases could be delayed and our revenues could decline.
Physicians, hospitals and other health care providers may be reluctant to
purchase our products if they do not receive substantial reimbursement for the
cost of the procedures using our products from third-party payors, such as
Medicare, Medicaid and private health insurance plans. Although we were
notified in February 2002 by the American Medical Association that specific
reimbursement codes for radiofrequency ablation of liver tumors have been
established, they reserve the right to reverse this decision. In this case, we
would be required to reapply for a specific code. This process is time
consuming and costly and may require us to provide extensive supporting
scientific, clinical and cost-effectiveness data for our products to the
American Medical Association. Even though we were successful in establishing a
new code, a payor still may not reimburse adequately for the procedure or
product. In addition, there is no specific reimbursement code for
radiofrequency ablation of tumors
28
in other organs. Further, we believe the advent of fixed payment schedules has
made it difficult to receive reimbursement for disposable products, even if the
use of these products improves clinical outcomes. Fixed payment schedules
typically permit reimbursement for a procedure rather than a device. If
physicians believe that our system will add cost to a procedure but will not
add sufficient offsetting economic or clinical benefits, physician adoption
could be slowed.
You may have a difficult time evaluating our company as an investment because
we have a limited operating history.
You can only evaluate our business based on a limited operating history
because we began selling the RITA system in 1997. This short history may not be
adequate to enable you to fully assess our ability to achieve market acceptance
of our products and respond to competition.
Any failure to build and manage our direct sales organization may negatively
affect our revenues.
We have significantly expanded our direct sales force in the United States
over the past twelve months and plan to continue to increase the domestic
direct sales force in the future. There is intense competition for skilled
sales and marketing employees, especially for people who have experience
selling disposable devices and generators to the physicians in our target
market, and we may be unable to hire skilled individuals to sell our products.
Any inability to build and effectively manage our direct sales force could
negatively impact our growth.
We depend on key employees in a competitive market for skilled personnel and
without additional employees, we cannot grow or achieve profitability.
We are highly dependent on the principal members of our management,
operations and research and development staff. Our future success will depend
in part on the continued service of these individuals and our ability to
identify, hire and retain additional personnel, including sales and marketing
staff. The market for qualified management personnel in Northern California,
where our offices are located, is competitive and is expected to continue to be
competitive. Because the environment for good personnel is so competitive,
costs related to compensation may increase significantly. If we are unable to
attract and retain the personnel we need to support and grow our business, our
business will suffer.
We may be subject to costly and time-consuming product liability actions.
We manufacture medical devices that are used on patients in both minimally
invasive and open surgical procedures and as a result, we may be subject to
product liability lawsuits. To date, we have not been subject to a product
liability claim; however, any product liability claim brought against us, with
or without merit, could result in the increase of our product liability
insurance rates or the inability to secure coverage in the future. In addition,
we could have to pay any amount awarded by a court in excess of policy limits.
Finally, even a meritless or unsuccessful product liability claim could be time
consuming and expensive to defend and could result in the diversion of
management's attention from managing our core business.
Any failure in our physician training efforts could result in lower than
expected product sales.
It is critical to our sales effort to train a sufficient number of
physicians and to instruct them properly in the procedures that utilize our
products. We have established formal physician training programs and rely on
physicians to devote adequate time to understanding how and when our products
should be used. If physicians are not properly trained, they may misuse or
ineffectively use our products. This may result in unsatisfactory patient
outcomes, patient injury and related liability or negative publicity that could
have an adverse effect on our product sales.
29
We may incur significant costs related to a class action lawsuit due to the
likely volatility of our stock.
Our stock price may fluctuate for a number of reasons including:
. failure of the public market to support the valuation established in our
initial public offering;
. our ability to successfully commercialize our products;
. announcements regarding patent litigation or the issuance of patents to us
or our competitors;
. quarterly fluctuations in our results of operations;
. announcements of technological or competitive developments;
. regulatory developments regarding us or our competitors;
. acquisitions or strategic alliances by us or our competitors;
. changes in estimates of our financial performance or changes in
recommendations by securities analysts; and
. general market conditions, particularly for companies with small market
capitalizations.
Securities class action litigation is often brought against a company after
a period of volatility in the market price of its stock. If our future
quarterly operating results are below the expectations of securities analysts
or investors, the price of our common stock would likely decline. Stock price
fluctuations may be exaggerated if the trading volume of our common stock is
low. Any securities litigation claims brought against us could result in
substantial expense and divert management's attention from our core business.
If we fail to support our anticipated growth in operations, our business could
suffer.
If we fail to execute our sales strategy and develop further our products,
our business could suffer. To manage anticipated growth in operations, we must
increase our quality assurance staff for both our generators and our disposable
devices and expand our manufacturing staff and facility for our disposable
devices. Our systems, procedures and controls may not be adequate to support
our expected growth in operations.
We have limited experience manufacturing our disposable devices in substantial
quantities, and if we are unable to hire sufficient additional personnel,
purchase additional equipment or are otherwise unable to meet customer demand
our business could suffer.
To be successful, we must manufacture our products in substantial quantities
in compliance with regulatory requirements at acceptable costs. If we do not
succeed in manufacturing quantities of our disposable devices that meet
customer demand, we could lose customers and our business could suffer. At the
present time, we have limited high-volume manufacturing experience. Our
manufacturing operations are currently focused on the in-house assembly of our
disposable devices. As we increase our manufacturing volume and the number of
product designs for our disposable devices, the complexity of our manufacturing
processes will increase. Because our manufacturing operations are primarily
dependent upon manual assembly, if demand for our system increases we will need
to hire additional personnel and may need to purchase additional equipment. If
we are unable to sufficiently staff our manufacturing operations or are
otherwise unable to meet customer demand for our products, our business could
suffer.
We are dependent on one supplier as the only source of a component that we use
in our disposable devices, and any disruption in the supply of this component
could negatively affect our revenues.
Because there is only one supplier that provides us with a component that we
include in our disposable devices, a disruption in the supply of this component
could negatively affect revenues. This supplier is the only source of this
component. If we were unable to remedy a disruption in supply of this component
within twelve
30
months, we could be required to redesign the handle of our disposable devices,
which could divert engineering resources from other projects or add to product
costs. In addition, a new or supplemental filing with applicable regulatory
authorities may require clearance prior to our marketing a product containing
new materials. This clearance process may take a substantial period of time,
and we may be unable to obtain necessary regulatory approvals for any new
material to be used in our products on a timely basis, if at all. This could
also create supply disruptions that could negatively affect our business.
We are dependent on third-party contractors for the supply of our generators,
and any failure to deliver generators to us could result in lower than expected
revenues.
We are dependent on two third-party suppliers to produce our generators.
While we have agreements with both of these suppliers, any delay in shipments
of generators to us could result in our failure to ship generators to customers
and could negatively affect revenues.
Complying with the FDA and other domestic and international regulatory
authorities is an expensive and time-consuming process, and any failure to
comply could result in substantial penalties.
We are subject to a host of federal, state, local and international
regulations regarding the manufacture and marketing of our products. In
particular, our failure to comply with FDA regulations could result in, among
other things, seizures or recalls of our products, an injunction, substantial
fines and/or criminal charges against our employees and us. The FDA's medical
device reporting regulations require us to report any incident in which our
products may have caused or contributed to a death or serious injury, or in
which our products malfunctioned in a way that would be likely to cause or
contribute to a death or serious injury if the malfunction recurred.
Sales of our products outside the United States are subject to foreign
regulatory requirements that vary from country to country. The time required to
obtain approvals from foreign countries may be longer than that required for
FDA approval or clearance, and requirements for foreign licensing may differ
from FDA requirements. For example, some of our newer products have not
received approval in Japan. Any failure to obtain necessary regulatory
approvals for our new products in foreign countries could negatively affect
revenues.
Product introductions or modifications may be delayed or canceled as a result
of the FDA regulatory process, which could cause our revenues to be below
expectations.
Unless we are exempt, we must obtain the appropriate FDA approval or
clearance before we can sell a new medical device in the United States. This
can be a lengthy and time-consuming process. To date, all of our products have
received clearances from the FDA through premarket notification under Section
510(k) of the Federal Food, Drug and Cosmetic Act. However, if the FDA requires
us to submit a new premarket notification under Section 510(k) for
modifications to our existing products, or if the FDA requires us to go through
a lengthier, more rigorous examination than we now expect, our product
introductions or modifications could be delayed or canceled which could cause
our revenues to be below expectations. The FDA may determine that future
products will require the more costly, lengthy and uncertain premarket approval
process. In addition, modifications to medical device products cleared via the
510(k) process may require a new 510(k) submission. We have made minor
modifications to our system. Using the guidelines established by the FDA, we
have determined that some of these modifications do not require us to file new
510(k) submissions. If the FDA disagrees with our determinations, we may not be
able to sell the RITA system until the FDA has cleared new 510(k) submissions
for these modifications. In addition, we intend to request additional label
indications, such as approvals or clearances for the ablation of tumors in
additional organs, including lung, bone and breast, for our current products.
The FDA may either deny these requests outright, require additional extensive
clinical data to support any additional indications or impose limitations on
the intended use of any cleared product as a condition of approval or
clearance. Therefore, obtaining necessary approvals or clearances for these
additional applications could be an expensive and lengthy process.
31
We may need to raise additional capital in the future resulting in dilution to
our stockholders.
We may need to raise additional funds for our business operations and to
execute our business strategy. We may seek to sell additional equity or debt
securities or to obtain an additional credit facility. The sale of additional
equity or convertible debt securities could result in additional dilution to
our stockholders. If additional funds are raised through the issuance of debt
securities, these securities could have rights that are senior to holders of
common stock and could contain covenants that would restrict our operations.
Any additional financing may not be available in amounts or on terms acceptable
to us, if at all.
Our executive officers and directors own a large percentage of our voting stock
and could exert significant influence over matters requiring stockholder
approval.
Because our executive officers and directors, and their respective
affiliates, own approximately 28 percent of our outstanding common stock, these
stockholders may, as a practical matter, be able to exert significant influence
over matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other business combinations. This
concentration of voting stock could have the effect of delaying or preventing a
change in control.
Our certificate of incorporation, our bylaws, Delaware law and our stockholder
rights plan contain provisions that could discourage a takeover.
Provisions of our certificate of incorporation, our bylaws, Delaware law and
our stockholder rights plan contain provisions that may discourage, delay or
prevent a merger or acquisition that a stockholder may consider favorable.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Our exposure to interest rate risk at December 31, 2001 is related to our
investment portfolio; we have no interest rate sensitive borrowings as of that
date. Fixed rate investments and borrowings may have their fair market value
adversely impacted from changes in interest rates. Floating rate investments
may produce less income than expected if interest rates fall, and floating rate
borrowings will lead to additional interest expense if interest rates increase.
Due in part to these factors, our future investment income may fall short of
expectations, and our interest expense may be above our expectations. Further,
we may suffer losses in investment principal if we are forced to sell
securities that have declined in market value due to changes in interest rates.
We invest our excess cash in debt instruments of the United States
government and its agencies and in high quality corporate issuers. The average
contractual duration of our investments in 2001 was less than one year. Due to
the short-term nature of these investments, we believe that there is no
material exposure to interest rate risk arising from our investments.
All of our sales and purchases have historically been denominated in United
States dollars. In the future, we may begin to make sales in other currencies
such as the Euro. We believe we currently have no significant direct foreign
currency exchange rate risk and that such risk in the future will be minimal.
32
Item 8. Consolidated Financial Statements and Supplementary Data.
RITA Medical Systems, Inc.
Index to Consolidated Financial Statements
Page
----
Report of Independent Accountants.................................... 34
Consolidated Balance Sheets.......................................... 35
Consolidated Statements of Operations and Comprehensive Loss......... 36
Consolidated Statements of Stockholders' Equity (Deficit)............ 37
Consolidated Statements of Cash Flows................................ 38
Notes to Consolidated Financial Statements........................... 39
33
Report of Independent Accountants
To the Stockholders and Board of Directors
of RITA Medical Systems, Inc.
In our opinion, the consolidated financial statements listed in the
accompanying index appearing under Item 14 on page 55, present fairly, in all
material respects, the financial position of RITA Medical Systems, Inc. and its
subsidiaries at December 31, 2001 and 2000, and the results of their operations
and their cash flows for each of the three years in the period ended December
31, 2001 in conformity with accounting principles generally accepted in the
United States of America. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
San Jose, CA
January 23, 2002
34
RITA MEDICAL SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
December 31,
------------------
2001 2000
-------- --------
ASSETS
Current assets:
Cash and cash equivalents............................................................ $ 7,297 $ 12,676
Marketable securities................................................................ 11,887 27,381
Accounts receivable, net of allowance for doubtful accounts of $629 at December 31,
2001 and $103 at December 31, 2000................................................. 5,056 2,437
Inventories, net..................................................................... 3,645 1,638
Prepaid assets and other current assets.............................................. 1,282 823
-------- --------
Total current assets.......................................................... 29,167 44,955
Long term marketable securities...................................................... 4,353 --
Property and equipment, net.......................................................... 1,934 1,255
Other assets......................................................................... 380 60
-------- --------
Total assets.................................................................. $ 35,834 $ 46,270
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable..................................................................... $ 822 $ 425
Accrued liabilities.................................................................. 2,675 1,895
Current portion of revolving term loan............................................... -- 833
Current portion of capital lease obligations......................................... 192 290
-------- --------
Total current liabilities..................................................... 3,689 3,443
Capital lease obligations, net of current portion....................................... -- 180
-------- --------
Total liabilities............................................................. 3,689 3,623
-------- --------
Commitments and contingencies (Note 5)
Stockholders' equity:
Preferred stock, $0.001 par value:
Authorized: 2,100 shares at December 31, 2001 and 2,000 shares at
December 31, 2000
Issued and outstanding: No shares at December 31, 2001 and December 31,
2000........................................................................... -- --
Common stock, $0.001 par value:
Authorized: 100,000 shares at December 31, 2001 and December 31, 2000
Issued and outstanding: 14,591 shares at December 31, 2001 and 13,970 shares
at December 31, 2000........................................................... 15 14
Additional paid-in capital........................................................... 88,459 88,421
Deferred stock-based compensation.................................................... (1,905) (4,202)
Stockholder notes receivable......................................................... (99) (164)
Accumulated other comprehensive income............................................... 70 13
Accumulated deficit.................................................................. (54,395) (41,435)
-------- --------
Total stockholders' equity.................................................... 32,145 42,647
-------- --------
Total liabilities and stockholders' equity.................................... $ 35,834 $ 46,270
======== ========
See accompanying notes
35
RITA MEDICAL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(in thousands, except per share data)
Years Ended December 31,
---------------------------
2001 2000 1999
-------- -------- -------
Sales..................................................................... $ 14,791 $ 10,010 $ 4,629
Cost of goods sold (including stock-based compensation of $558, $926, and
$107 in 2001, 2000 and 1999, respectively).............................. 6,132 6,048 2,994
-------- -------- -------
Gross profit........................................................... 8,659 3,962 1,635
-------- -------- -------
Operating Expenses:
Research and Development (including stock-based compensation of $465, $998
and $354 in 2001, 2000 and 1999 respectively)........................... 6,489 5,615 3,931
Selling, general and administrative (including stock-based compensation of
$349, $2,898 and $530 in 2001, 2000 and 1999 respectively).............. 16,646 12,052 5,452
-------- -------- -------
Total operating expenses............................................... 23,135 17,667 9,383
-------- -------- -------
Loss from operations...................................................... (14,476) (13,705) (7,748)
Interest income........................................................... 1,610 1,585 446
Interest expense.......................................................... (86) (683) (212)
Other income (expense), net............................................... (8) (4) 4
-------- -------- -------
Net loss.................................................................. (12,960) (12,807) (7,510)
Other comprehensive income (expense):
Change in unrealized gain (loss) on marketable securities.............. 57 20 (9)
-------- -------- -------
Comprehensive loss........................................................ $(12,903) $(12,787) $(7,519)
======== ======== =======
Net loss per common share, basic and diluted.............................. $ (0.90) $ (1.99) $ (9.33)
======== ======== =======
Shares used in computing net loss per share, basic and diluted............ 14,353 6,440 805
======== ======== =======
See accompanying notes
36
RITA MEDICAL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(In thousands)
Accumulated Total
Common Stock Additional Deferred Stockholder Other Shareholders'
-------------- Paid-in Stock-based Note Comprehensive Accumulated Equity/
Shares Amount Capital Compensation Receivable Gain/(Loss) Deficit (Deficit)
Issued $ $ $ $ $ $ $
------ ------ ---------- ------------ ----------- ------------- ----------- -------------
Balances, December 31, 1998..... 778 $ 1 $ 1,538 $ (933) $ -- $ 2 $(21,118) $(20,510)
Stock options exercised......... 149 -- 92 -- (73) -- -- 19
Stock compensation.............. -- -- 28 -- -- -- -- 28
Deferred stock-based
compensation................... -- -- 1,993 (1,993) -- -- -- --
Amortization of deferred stock-
based compensation............. -- -- -- 991 -- -- -- 991
Change in unrealized gain on
marketable securities.......... -- -- -- -- -- (9) -- (9)
Net loss........................ -- -- -- -- -- -- (7,510) (7,510)
------ --- ------- ------- ----- --- -------- --------
Balances, December 31, 1999..... 927 1 3,651 (1,935) (73) (7) (28,628) (26,991)
Conversion of preferred stock to
common stock................... 8,911 9 38,505 -- -- 38,514
Issuance of common stock, net... 3,600 3 38,716 -- -- 38,719
Stock options and warrants
exercised...................... 532 1 460 -- (91) 370
Deferred stock-based
compensation................... -- -- 7,089 (7,089) -- --
Amortization of deferred stock-
based compensation............. -- -- -- 4,822 -- 4,822
Change in unrealized gain on
marketable securities.......... -- -- -- -- -- 20 20
Net loss........................ -- -- -- -- -- -- (12,807) (12,807)
------ --- ------- ------- ----- --- -------- --------
Balances, December 31, 2000..... 13,970 14 88,421 (4,202) (164) 13 (41,435) 42,647
Issuance of common stock, net... 89 -- 324 -- -- 324
Stock options and warrants
exercised...................... 551 1 406 -- 407
Cancellation of common stock.... (19) -- (31) 31 --
Issuance of common stock
warrants for services
received....................... 264 264
Deferred stock-based
compensation................... -- -- (925) 925 --
Amortization of deferred stock-
based compensation............. -- -- -- 1,372 1,372
Forgiveness of stockholder note
receivable, net................ 34 34
Change in unrealized gain on
marketable securities.......... -- -- -- -- -- 57 57
Net loss........................ -- -- -- -- -- -- (12,960) (12,960)
------ --- ------- ------- ----- --- -------- --------
Balances, December 31, 2001..... 14,591 $15 $88,459 $(1,905) $ (99) $70 $(54,395) $ 32,145
====== === ======= ======= ===== === ======== ========
See accompanying notes
37
RITA MEDICAL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended December 31,
---------------------------
2001 2000 1999
-------- -------- -------
Cash flows from operating activities:
Net loss............................................................... $(12,960) $(12,807) $(7,510)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation and amortization........................................ 1,018 1,019 399
Issuance of common stock for services received....................... -- -- 2
Issuance of common stock warrants for services received.............. 264 -- --
Allowance for doubtful accounts...................................... 526 49 25
Provision for obsolete inventories................................... 137 17 105
Amortization of stock-based compensation............................. 1,372 4,822 991
Changes in operating assets and liabilities:.........................
Accounts receivable................................................ (3,145) (1,338) (886)
Inventory.......................................................... (2,144) (809) (698)
Prepaid and other current assets................................... (459) (323) 26
Accounts payable and accrued liabilities........................... 1,177 472 674
-------- -------- -------
Net cash used in operating activities................................ (14,214) (8,898) (6,872)
-------- -------- -------
Cash flows from investing activities:
Purchase of property and equipment..................................... (1,648) (856) (441)
Purchase of short-term investments..................................... (15,114) (32,295) (7,061)
Maturities of short-term investments................................... 30,650 10,020 4,290
Purchase of long-term investments...................................... (4,337) -- --
Capitalization of patent litigation costs.............................. (332) -- --
Notes receivable and other assets...................................... 6 6 (48)
-------- -------- -------
Net cash provided by (used in) investing activities.................. 9,225 (23,125) (3,260)
-------- -------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock................................. 731 39,087 45
Proceeds from issuance of preferred stock.............................. -- -- 9,947
Proceeds from long-term debt........................................... -- 1,500 1,500
Payments on long-term debt............................................. -- (3,000) --
Proceeds from revolving term loan...................................... 25 800 551
Payments on revolving term loan........................................ (858) (500) (19)
Payments on capital lease obligations.................................. (288) (255) (147)
-------- -------- -------
Net cash provided by (used in) financing activities.................. (390) 37,632 11,877
-------- -------- -------
Net increase (decrease) cash and cash equivalents....................... (5,379) 5,609 1,745
Cash and cash equivalents at beginning of year.......................... 12,676 7,067 5,322
-------- -------- -------
Cash and cash equivalents at end of year................................ $ 7,297 $ 12,676 $ 7,067
======== ======== =======
Supplemental disclosures of cash flow information:
Cash paid for taxes.................................................... $ 8 $ 6 $ 2
Cash paid for interest................................................. 75 460 183
Supplemental disclosures of noncash financing activities:
Issuance of preferred stock warrants in connection with long term debt. -- -- 232
Equipment purchased under capital leases............................... -- 319 557
See accompanying notes
38
RITA Medical Systems, Inc.
Notes to Financial Statements
NOTE 1: FORMATION AND BUSINESS OF THE COMPANY
RITA Medical Systems, Inc. (formerly ZoMed International, Inc.) (the
"Company") was incorporated in January 1994. The Company is engaged in
developing, manufacturing and marketing innovative products that use
radiofrequency energy to treat patients with solid cancerous or benign tumors.
Products include radiofrequency generators and a family of disposable needle
electrode devices that deliver controlled thermal energy to targeted tissue.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements include the accounts of
RITA Medical Systems, Inc. and its wholly owned subsidiary, RITA Medical
Systems Netherlands, BV. Intercompany transactions and accounts have been
eliminated.
Use of estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that effect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Significant estimates include those
required in the assessment of allowances for doubtful accounts and for
potentially excess and obsolete inventory. Actual results could differ from
those estimates.
Concentration of credit risk and other risks and uncertainties
The Company's products include components subject to rapid technological
change. Certain components used in manufacturing the product have relatively
few alternative sources of supply and establishing additional or replacement
suppliers for such components cannot be accomplished quickly. While the Company
has ongoing programs to minimize the adverse effect of such changes and
considers technological change in estimating its allowances, such estimates
could change in the future.
Financial instruments that potentially subject the Company to a
concentration of credit risk consist of cash and cash equivalents, marketable
securities and accounts receivable. Cash and cash equivalents are deposited in
demand and money market accounts in three financial institutions in the United
States and one financial institution in the Netherlands. Deposits held with
financial institutions may exceed the amount of insurance provided on such
deposits. The Company has not experienced any losses on its deposits of cash,
cash equivalents or marketable securities.
The Company extends credit to its customers, which are primarily comprised
of accounts of private companies in the United States, Europe and Asia. The
Company performs ongoing credit evaluations of its customers' financial
conditions and generally requires no collateral. The Company maintains an
allowance for doubtful accounts receivable based on the expected collectibility
of individual accounts. Provisions to the allowance for doubtful accounts were
approximately $535,000, $50,000 and $27,000 for the years ended December 31,
2001, 2000 and 1999, respectively. Charges against the allowance were
approximately $9,000, $1,000 and $2,000 for the years ended December 31, 2001,
2000 and 1999, respectively.
39
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Cash and cash equivalents
All highly liquid investments with original maturities of ninety days or
less from the date of purchase are considered to be cash equivalents.
Marketable securities
The Company's marketable securities are categorized as available-for-sale,
as defined by Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities." Marketable securities with original maturities
greater than three months and less than one year are classified as short-term
investments. Marketable securities with original maturities greater than one
year are classified as long-term investments. Unrealized holding gains and
losses are reflected as a net amount in a separate component of stockholders
equity (deficit) until realized. For the purpose of computing realized gains
and losses, cost is identified on a specific identification basis.
Fair Value of Financial Instruments
The carrying amounts of some of the Company's financial instruments
including cash and cash equivalents, accounts receivable and accounts payable
approximate fair value due to their short maturities. Based on borrowing rates
currently available to the Company for loans with similar terms, the carrying
value of its debt obligations approximates fair value.
Inventories
Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market. The Company records provisions to write down its
inventory for estimated obsolescence or unmarketable inventory equal to the
difference between the cost of the inventory and its estimated market value
based upon assumptions about future market demand and market conditions. If
future demand or market conditions are less favorable than currently expected,
additional inventory provisions may be required. Provisions to the allowance
for excess and obsolete inventory were approximately $355,000, $139,000 and
$144,000 for the years ended December 31, 2001, 2000 and 1999 respectively.
Charges against the allowance were approximately $218,000, $122,000 and $39,000
for the years ended December 31, 2001, 2000 and 1999 respectively.
Property and Equipment
Property and equipment is stated at cost less accumulated depreciation and
amortization. Depreciation and amortization of property and equipment is
computed using the straight-line method over the estimated useful lives of the
respective assets as follows:
Machinery and equipment.................................... 1 to 5 years
Computers and software..................................... 3 to 5 years
Furniture and fixtures..................................... 5 years
Leasehold improvements are amortized over their estimated useful lives, or
the remaining lease term, whichever is shorter, using the straight-line method.
Upon sale or retirement, the asset's cost and related accumulated depreciation
are removed from the accounts and any related gain or loss is reflected in
operations.
40
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Long-lived assets
The Company periodically assesses the impairment of its long-lived assets in
accordance with the provisions of SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." An
impairment review is performed whenever events or changes in circumstances
indicate that the carrying value of the Company's long-lived assets may not be
recoverable. Indicators which could trigger an impairment review include, but
are not limited to, significant underperformance relative to past or planned
operating results, significant changes in the strategy for the overall
business, significant negative industry trends and/or a significant decline in
the stock price of the Company for a sustained period of time. When it is
determined, based on one or more of these indicators, that the carrying value
of the Company's long-lived assets may not be recoverable, impairment is
measured using the projected discounted cash flow method and charged to
operations.
Intangible assets
Litigation costs incurred in defense of the Company's patent positions have
been capitalized and are carried at cost less accumulated amortization.
Amortization of these costs is computed using the straight-line method over the
remaining life of the related patents, which was approximately 11 years as of
December 31, 2001.
Revenue recognition
Revenue is recognized upon receipt of a customer purchase order and
subsequent product shipment, provided no significant obligations remain and
collection of the associated receivable is deemed probable. This policy is
applied to all the Company's customers, including distributors, who have no
price protection or return rights on product purchased.
Research and Development
Research and development costs are expensed as incurred. Research and
development costs consist of direct and indirect internal costs related to
specific projects as well as fees paid to other entities that conduct certain
research activities on behalf of the Company.
Advertising
Advertising production costs are expensed as incurred. Media for print
placement costs are expensed in the period the advertising appears. Total
advertising and promotional expenses were approximately $169,000, $100,000 and
$48,000 for the years ended December 31, 2001, 2000 and 1999, respectively.
Income Taxes
Income taxes are accounted for using the liability method under which
deferred tax assets and liabilities are determined based on the difference
between the financial statement and tax bases of assets and liabilities using
enacted tax rates in effect for the year in which the differences are expected
to affect taxable income. Valuation allowances are established when necessary
to reduce deferred tax assets to the amount expected to be realized. Provisions
to the allowance were approximately $3,419,000, $3,038,000 and $2,485,000 for
the years ended December 31, 2001, 2000 and 1999, respectively.
41
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Accounting for stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25"). Financial Accounting
Standards Board Interpretations ("FIN") No. 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans" and
complies with the disclosure provisions of Statements of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123").
Under APB No. 25, compensation expense is based on the difference, if any,
on the date of the grant between the fair value of the Company's stock and the
exercise price. SFAS No. 123 defines a "fair value" based method of accounting
for an employee stock option or similar equity instruments. The pro forma
disclosures of the difference between compensation expense included in net loss
and the related cost measured by the fair value method are presented in Note 7.
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Task Force Issue
No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services."
Net loss per share
Basic earnings per share is calculated based on the weighted-average number
of common shares outstanding during the period less the weighted average number
of any common shares subject to repurchase by the Company. Diluted earnings per
share further includes the dilutive effect of common stock equivalents
consisting of stock options, warrants and shares issuable upon conversion of
preferred stock provided that the inclusion of such securities is not
antidilutive; the Company has reported net losses since its inception and
therefore excludes such potentially dilutive securities from its calculation of
diluted earnings per share.
The reconciliation of total outstanding common shares to shares used in
determining net loss per share is as follows (in thousands):
Years ended December 31,
------------------------
2001 2000 1999
------- ------- ------
Net loss, basic and diluted........................................ $12,960 $12,807 $7,510
======= ======= ======
Weighted-average shares of common stock outstanding................ 14,419 6,514 805
Less: weighted-average shares subject to repurchase................ 66 74 --
------- ------- ------
Weighted-average shares used in basicand diluted net loss per share 14,353 6,440 805
======= ======= ======
42
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
The following numbers of shares represented by options and warrants (prior
to application of the treasury stock method), shares subject to repurchase and
convertible preferred stock (on an as-if converted basis) were excluded from
the computation of diluted net loss per share as their effect was antidilutive
(in thousands):
Years ended
December 31,
-----------------
2001 2000 1999
----- ----- -----
Effect of common stock equivalents:
Unvested common stock subject to repurchase............. 66 74 --
Options outstanding..................................... 2,438 1,890 1,483
Warrants outstanding.................................... 19 186 217
Shares resulting from the conversion of the:
Series A convertible preferred stock.................... -- 557 958
Series B convertible preferred stock.................... -- 824 1,415
Series C convertible preferred stock.................... -- 648 1,113
Series D convertible preferred stock.................... -- 185 318
Series E convertible preferred stock.................... -- 2,986 3,746
----- ----- -----
Total common stock equivalents excluded from the
computation of earnings per share as their effect was
antidilutive............................................. 2,523 7,350 9,250
===== ===== =====
Recent accounting pronouncements
In July 2001, the Financial Accounting and Standards Board ("FASB") issued
Statements of Financial Accounting Standards No. 141 ("SFAS 141"), "Business
Combinations," and No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets." SFAS 141 requires that all business combinations initiated after June
20, 2001 be accounted for under the purchase method. Use of the
pooling-of-interests method is no longer permitted. SFAS 142 requires that
goodwill no longer be amortized to earnings, but instead be reviewed for
impairment upon initial adoption of the Statement and on an annual basis going
forward. The amortization of goodwill will cease upon adoption of SFAS 142. The
provisions of SFAS 142 will be effective for fiscal years beginning after
December 15, 2001. The Company is required to adopt SFAS 142 in the first
quarter of 2002. We believe that adoption of these standards will have no
impact on our financial statements.
In October 2001, the FASB issued Statement of Financial Accounting Standards
No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal of
Long-Lived Assets," which is effective for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal periods. This
Statement supersedes FASB Statement No. 121 and APB 30, however, this Statement
retains the requirement of Opinion 30 to report discontinued operations
separately from continuing operations and extends that reporting to a component
of an entity that either has been disposed of (by sale, by abandonment, or in a
distribution to owners) or is classified as held for sale. This Statement
addresses financial accounting and reporting for the impairment of certain
long-lived assets and for long-lived assets to be disposed of. Management does
not expect the adoption of SFAS No. 144 to have a material impact on the
Company's financial position and results of operations.
In May 2000, the Emerging Issues Task Force (EITF) issued EITF Issue No.
00-14, "Accounting for Certain Sales Incentives," addressing the recognition,
measurement and income statement classification of sales incentives that a
vendor voluntarily offers to its customers, without charge, and which customers
may then use in, or exercise as a result of, a single exchange transaction.
Sales incentives falling within the scope of EITF Issue No. 00-14 include
offers that customers may use to receive a reduction in the price of products
or services at the point of sale. In June 2001, the EITF issued EITF Issue No.
00-25, "Vendor Income Statement Characterization
43
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
of Consideration Paid to a Reseller of the Vendor's Products," addressing
whether consideration from a vendor to a reseller is (a) an adjustment to the
selling prices of the vendor's products and therefore a deduction from revenue
when recognized in the vendor's statement of operations or (b) a cost incurred
by the vendor for assets or services received from the reseller and therefore a
cost or expense when recognized in the vendor's statement of operations. In
September 2001, the EITF issued Issue No. 01-09, "Accounting for Consideration
Given by a Vendor to a Customer or a Reseller of the Vendor's Products," which
is a codification of EITF Issues No. 00-14, No. 00-25 and also No. 00-22,
"Accounting for 'Points' and Certain Other Time or Volume-Based Sales Incentive
Offers and Offers for Free Products or Services to be Delivered in the Future."
The requirements of EITF Issue No. 01-09, as with the preceding Issues No.
00-14, No. 00-22 and No. 00-25, became effective for annual or interim
financial statements dated after December 15, 2001, and include a requirement
to reclassify the financial statements of prior periods as necessary to conform
with current income statement display standards. No material impact on our
financial statements has resulted from the adoption of the EITF Issues above.
NOTE 3: BALANCE SHEET COMPONENTS
Marketable Securities (in thousands):
The cost and fair value of available-for-sale securities at December 31,
2001 were as follows:
Cost Unrealized Fair
Securities with original maturities 91 days to 1 year: Value Gain/(Loss) Value
- ------------------------------------------------------ ------- ----------- -------
Corporate Notes............................................ $ 3,420 $ 23 $ 3,443
Market Auction Preferred................................... 2,300 -- 2,300
US Government Agency Notes................................. 6,113 31 6,144
------- ---- -------
$11,833 $ 54 $11,887
======= ==== =======
Cost Unrealized Fair
Securities with original maturities greater than 1 year: Value Gain/(Loss) Value
- -------------------------------------------------------- ------- ----------- -------
Corporate Notes............................................ $ 1,550 $ 26 $ 1,576
Foreign Debt Securities.................................... 2,787 (10) 2,777
------- ---- -------
$ 4,337 $ 16 $ 4,353
======= ==== =======
Securities with original maturities greater than one year have been reported
as long-term investments.
The cost and fair value of available-for-sale securities at December 31,
2000 were as follows:
Cost Unrealized Fair
Securities with original maturities 91 days to 1 year: Value Gain/(Loss) Value
- ------------------------------------------------------ ------- ----------- -------
Corporate commercial paper................................. $15,290 $(2) $15,288
Corporate notes............................................ 12,078 15 12,093
------- --- -------
$27,368 $13 $27,381
======= === =======
44
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Inventories (in thousands):
December 31,
-------------
2001 2000
------ ------
Raw materials.............................................. $1,017 $ 404
Work in progress........................................... 377 203
Finished goods............................................. 2,251 1,031
------ ------
$3,645 $1,638
====== ======
Property and equipment (in thousands):
December 31,
----------------
2001 2000
------- -------
Computer equipment and software............................ $ 867 $ 594
Furniture and fixtures..................................... 187 90
Leasehold improvements..................................... 740 207
Machinery and equipment.................................... 3,275 2,531
------- -------
5,069 3,422
Less: accumulated depreciation and amortization............ (3,135) (2,167)
------- -------
$ 1,934 $ 1,255
======= =======
Property and equipment includes approximately $636,000 of machinery,
equipment and other assets under capital lease at both December 31, 2001 and
December 31, 2000. Accumulated amortization of assets under capital lease
totaled approximately $443,000 at December 31, 2001 and $324,000 at December
31, 2000.
Other Assets (in thousands):
December 31,
------------
2001 2000
---- ----
Capitalized patent defense litigation costs................ $332 $--
Deposits................................................... 46 46
Other non-current assets................................... 8 14
---- ---
386 60
Less: accumulated amortization............................. (6) --
---- ---
$380 $60
==== ===
Accrued Liabilities (in thousands):
December 31,
-------------
2001 2000
------ ------
Payroll and related expenses............................... $1,177 $ 864
Accrued vacation........................................... 277 197
Accrued legal expenses..................................... 247 23
Product received but not yet invoiced...................... 217 52
Other accrued liabilities.................................. 757 759
------ ------
$2,675 $1,895
====== ======
45
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
NOTE 4: DEBT
Notes Payable
In June 1999, the Company entered into a loan and security agreement for a
loan facility of up to $5,000,000, consisting of two term loans of $1,500,000
each and a revolving term loan of up to $2,000,000. In connection with this
agreement, the Company issued warrants to purchase 85,091 shares of its then
authorized Series E preferred stock (Note 6).
As of December 31, 1999, the Company had drawn down the initial term loan of
$1,500,000. In February 2000, the Company drew down the second term loan of
$1,500,000. Both term loans were repaid in full in September 2000.
As of December 31, 2000, the Company had borrowed approximately $833,000
under the revolving term loan. This loan was completely repaid as of June 30,
2001, and the loan facility was cancelled.
NOTE 5: COMMITMENTS AND CONTINGENCIES
Capital lease
In September 1998, the Company entered into a three year capital lease
agreement and was permitted to borrow up to $1,000,000 for equipment
deliverable no later than March 31, 2000. In conjunction with this lease
agreement, the Company issued warrants which are now exchangeable for 10,909 of
its common shares at $4.58 per share. As of December 31, 2001, future minimum
payments under this capital lease agreement are as follows (in thousands):
Payments due in 2002....................................... $204
Less imputed interest (including warrants)................. (12)
----
Present value of future minimum lease payments............. $192
====
Operating Leases
The Company leases manufacturing and office space under a 60 month
noncancelable operating lease terminating in August 2004. The base rent will
increase according to the CPI formula as stipulated in the lease agreement.
Under the terms of the lease, the Company is responsible for property taxes,
insurance and maintenance costs. The Company sublet a portion of its facilities
through October, 2000. Rent expense, net of sublease income, was approximately
$475,000, $323,000 and $296,000 for the years ended December 31, 2001, 2000 and
1999 respectively. Future minimum annual rental payments are as follows (in
thousands):
2002....................................................... $ 530
2003....................................................... 533
2004....................................................... 356
------
$1,419
======
46
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Contingencies
In July 1999, the United States Patent and Trademark Office declared an
interference involving us, which was provoked by RadioTherapeutics Corporation,
a competitor of ours, in which the validity of a patent claim previously issued
to us is being called into question. The claim being questioned is one of a
number of issued patent claims that cover the curvature of the array at the tip
of our disposable devices. In February 2001, the USPTO issued a decision on
preliminary motions filed in the patent interference proceeding. The decision
found that one of the claims in our United States Patent No. 5,536,267 (claim
no. 32) is invalid. We expect to receive final confirmation of that decision
later this year. In the event that the decision is confirmed, we plan to file a
motion in a United States District Court requesting review of the decision.
Final determination of the patent interference proceeding may take several
years. If the final determination of the United States District Court results
in the issuance of patent rights related to the claim to RadioTherapeutics and
we were unable to obtain a license to use the relevant patent or successfully
modify our disposable device, we could be unable to sell our system and our
business could suffer.
The Company is also involved in a patent opposition action pending before
the European Patent Office. This opposition was instituted on March 2, 2000.
The principal parties are RadioTherapeutics and RITA. The factual basis
underlying the claim is the allegation by RadioTherapeutics that our European
patent is not valid. In the opposition, RadioTherapeutics seeks to have our
patent declared invalid and to have our patent cancelled. We are defending our
patent and seek to defend it as issued. On February 7, 2002, the European
Patent Office determined that we are entitled to European Patent No. 0777445
which covers radiofrequency ablation technology. The European Patent Office
approved 27 claims. A final decision is not expected in this proceeding for
several years. If we do not prevail in the opposition proceeding, we could lose
our only currently issued patent in Europe.
In August 2001 the Company filed a complaint in the United States District
Court for the Northern District of California against RadioTherapeutics
Corporation. This complaint, which is distinct from the patent interference
proceeding described above, alleges that RadioTherapeutics' radiofrequency
ablation products infringe six different patents held by the Company. As of
December 31, 2001, the Company has capitalized approximately $332,000 in
litigation costs incurred in defense of its patent positions (see Notes 2 and
3).
NOTE 6: STOCKHOLDERS' EQUITY
Stock split
On May 1, 2000, the board of directors approved a 3-for-5 reverse stock
split of the common and then outstanding preferred stock. Stockholders'
approval of the reverse stock split was obtained on June 20, 2000. All share
and per share amounts in the accompanying financial statements have been
adjusted retroactively.
Initial public offering of common stock
On July 26, 2000, the Company completed its initial public offering of
3,600,000 shares of common stock at a price of $12.00 per share, raising
approximately $39.1 million net of underwriting discounts, commissions and
other offering costs. Upon closing of the offering, all of the Company's then
outstanding convertible preferred stock converted into approximately 8.9
million shares of common stock.
47
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Warrants
In connection with its September 1998 capital lease arrangement, the Company
issued warrants which are now exchangeable for 10,909 common shares at $4.58
per share. These warrants expire in September 2006. Their aggregate fair value
of $31,273, based on the Black-Scholes valuation model, has been reflected as a
discount on the lease obligation and has been fully amortized as of December
31, 2001.
In connection with its 1999 loan and security agreement, the Company issued
warrants to purchase 85,091 shares of its then authorized Series E preferred
shares at a price of $4.58 per share. Their fair value of $231,646, based on
the Black-Scholes valuation model, was charged to operations in 2000. The
holder completed a net issue exercise in January 2001, converting all of the
warrants into 52,591 shares of the Company's common stock.
In October 2001, the Company issued a warrant to a former employee under the
terms of the employee's separation agreement. The warrant is exchangeable for
25,000 shares of the Company's common stock at a price of $3.10 per share and
expires in March 2003. Its aggregate fair value of $34,568, based on the
Black-Scholes valuation model, has been charged to operations.
In December 2001, the Company issued a warrant to BEKL Corporation under the
terms of a clinical data and patent license agreement. The warrant is
exchangeable for 25,000 shares of the Company's common stock at a price of
$6.10 per share and expires in December 2006. Its aggregate fair value of
$109,553 as of December 31, 2001, based on the Black-Scholes valuation model,
has been charged to operations. The fair value of this warrant will be
reassessed periodically, and adjusting entries will be recorded, until it is
exercised or expires. Further, BEKL Corporation will be awarded additional
performance based warrants in the future based on achievement of milestones in
the clinical data and patent license agreement. In December 2001, the Company
accrued a $119,910 charge to operations, representing the Black-Scholes fair
value of a second warrant the Company expects to issue to BEKL Corporation in
2002.
48
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
NOTE 7: STOCK OPTIONS
Stock Options: 1994 Incentive Stock Plan
Under the 1994 Incentive Stock Plan, options were granted to employees and
non-employees at prices determined by the board of directors to be not lower
than 85% of the fair market value of the common stock for non-statutory stock
options or 100% of the fair market value of the common stock for incentive
stock options. (For individuals who at the time of grant owned stock
representing more than 10% of the voting power of all classes of outstanding
stock, options were granted at prices not lower than 110% of the fair value of
the common stock for both non-statutory and incentive stock options.) Options
granted under this plan become exercisable and vest on a cumulative basis at
the discretion of the board of directors and generally expire ten years from
the date of grant. The Company's board of directors has determined that no
future grants will be made under this plan. Activity under this plan has been
as follows (in thousands, except per share data):
Options Outstanding
-------------------------
Weighted
Average
Shares Aggregate Exercise
Available Shares Price Price
--------- ------ --------- --------
Balances, December 31, 1998... 315 1,360 $1,084 $0.80
Options granted............ (406) 406 404 1.00
Options exercised.......... -- (149) (92) 0.62
Options canceled........... 156 (155) (145) 0.94
---- ----- ------ -----
Balances, December 31, 1999... 65 1,462 1,251 0.86
Additional shares reserved. 900 -- -- --
Options granted............ (914) 914 2,172 2.38
Options exercised.......... -- (412) (468) 1.14
Options canceled........... 120 (122) (261) 2.14
---- ----- ------ -----
Balances, December 31, 2000... 171 1,842 2,694 1.46
Options exercised.......... -- (499) (407) 0.82
Options canceled........... -- (220) (455) 2.07
Shares removed from plan... (171) -- -- --
---- ----- ------ -----
Balances, December 31, 2001... -- 1,123 $1,832 $1.63
==== ===== ====== =====
49
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Stock Options: 2000 Director's Stock Option Plan
Under the 2000 Director's Stock Option Plan, shares of common stock have
been reserved for issuance to non-employee directors. Option grants have been
and will continue to be made at the fair market value of the common stock on
the date of the grant. Options granted under this plan become exercisable and
vest on a cumulative basis at the discretion of the board of directors and
generally expire ten years from the date of grant. Activity under this plan has
been as follows (in thousands, except per share data):
Options Outstanding
-------------------------
Weighted
Average
Shares Aggregate Exercise
Available Shares Price Price
--------- ------ --------- --------
Balances, December 31, 1999............ -- -- $ -- $ --
Shares reserved..................... 500 -- -- --
--- -- ---- -----
Balances, December 31, 2000............ 500 -- -- --
Options granted..................... (35) 35 175 5.01
--- -- ---- -----
Balances, December 31, 2001............ 465 35 $175 $5.01
=== == ==== =====
Stock Options: 2000 Stock Plan
The 2000 Stock Plan provides for the grant of incentive stock options to
employees and non-statutory stock options and stock purchase rights to
employees and consultants. A total of 2,000,000 common shares were originally
reserved for issuance under this plan at its creation in 2000 and 500,000
additional common shares were reserved for issuance during 2001. Automatic
increases to the shares available for issuance will occur on the first day of
each fiscal year through 2010 in the amount of the lesser of 1,000,000 shares,
7% of the Company's outstanding common stock on the last day of the preceding
fiscal year, or a lower number as determined by the board of directors.
Incentive stock options granted under this plan must have an exercise price of
at least 100% of the fair market value of the common stock on the date of the
grant, and at least 110% of the fair market value of the common stock if the
options are awarded to an employee who holds more than 10% of the total voting
power of all classes of the Company's stock. Options granted under this plan
become exercisable and vest on a cumulative basis at the discretion of the
board of directors and generally expire ten years from the date of grant.
Activity under the 2000 Stock Plan has been as follows (in thousands, except
per share data):
Options Outstanding
-------------------------
Weighted
Average
Shares Aggregate Exercise
Available Shares Price Price
--------- ------ --------- --------
Balances, December 31, 1999............ -- -- $ -- $ --
Shares reserved..................... 2,000
Options granted..................... (151) 151 1,569 10.39
------ ----- ------ ------
Balances, December 31, 2000............ 1,849 151 1,569 10.39
Additional shares reserved.......... 500 -- -- --
Options granted..................... (1,423) 1,423 6,426 4.52
Options canceled.................... 75 (75) (485) 6.47
------ ----- ------ ------
Balances, December 31, 2001............ 1,001 1,499 $7,510 $ 5.01
====== ===== ====== ======
50
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Stock Options: Options outstanding and exercisable
Options outstanding, from all plans, and exercisable as of December 31, 2001
are as follows by exercise price ranges (in thousands, except per share data):
Options Outstanding Options Exercisable
--------------------------------------------- ----------------------------
Weighted-Average
Range of Number Remaining Weighted-Average Number Weighted-Average
Exercise Prices Outstanding Contractual Life Exercise Price Outstanding Exercise Price
- --------------- ----------- ---------------- ---------------- ----------- ----------------
$0.50 to $1.00 777 6.90 years $0.92 647 $0.91
$1.67 to $3.10 386 7.47 years $2.33 123 $1.67
$3.20 to $3.55 474 9.25 years $3.27 47 $3.35
$3.75 to $5.00 428 9.18 years $4.29 69 $4.26
$5.01 to $11.63 592 8.43 years $7.62 151 $8.03
----- ---------- ----- ----- -----
2,657 8.11 years $3.58 1,037 $2.37
===== =====
2000 Employee Stock Purchase Plan
The Company's 2000 employee stock purchase plan was adopted in the second
quarter of 2000. A total of 650,000 common shares have been reserved for
issuance under this plan. Automatic increases will occur on the first day of
2002, 2003 and 2004 in amounts equal to the lesser of 650,000 shares, 4% of the
Company's outstanding common stock on the last day of the preceding year, or
such lesser number that board of directors determines. This plan permits
employees to purchase common shares at a price equal to the lower of 85% of the
fair market value of the common stock at the beginning of each offering period
or the end of each offering period. Employee purchases are nonetheless limited
to 15% of eligible cash compensation, and other restrictions regarding the
amount of annual purchases also apply.
Stock-based compensation
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123 ("SFAS No.123"), "Accounting for
Stock-Based Compensation." Had compensation cost for the incentive stock plans
been determined based on the fair value at the grant date for awards during
2001, 2000 and 1999, consistent with the provisions of SFAS No. 123, the
Company 's pro forma net loss and pro forma net loss per share would have been
as follows (in thousands, except per share data):
Years ended December 31,
---------------------------
2001 2000 1999
-------- -------- -------
Net loss, as reported...................................... $(12,960) $(12,807) $(7,510)
Net loss, pro forma........................................ $(14,079) $(13,353) $(7,589)
Net loss per share, as reported, basic and diluted......... $ (0.90) $ (1.99) $ (9.33)
Net loss per share, pro forma, basic and diluted........... $ (0.98) $ (2.07) $ (9.43)
Such pro forma disclosure may not be representative of future compensation
cost because options vest over several years and additional grants are
anticipated each year.
The weighted average fair values of options granted during 2001, 2000 and
1999 were $4.53, $2.32 and $0.14 respectively.
51
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Prior to the Company's initial public offering, the value of each option
grant was estimated using the minimum value method. The value of each option
grant was estimated on the date of grant using the Black-Scholes method with
the following weighted assumptions:
Years ended December 31,
-------------------------
2001 2000 1999
------- ------- -------
Volatility............................. 80% 75% 0%
Risk-free interest rate................ 4.54% 6.51% 5.54%
Expected life.......................... 5 years 5 years 5 years
Expected dividends..................... 0% 0% 0%
During 2001, 2000 and 1999, the Company recorded a total of approximately
$8.2 million of deferred stock-based compensation in accordance with APB No.
25, SFAS No. 123 and EITF 96-18, related to options granted to employees and
non-employees. For options granted to non-employees during 2001, 2000 and 1999,
the Company determined fair value using the Black-Scholes option pricing model
with the following assumptions: expected volatility of 75%, 50% and 50%,
respectively, a risk-free interest rate of 5.75% and deemed values of common
stock between $1.00 and $6.98 per share. Stock compensation expense is being
recognized in accordance with FIN 28 over the vesting periods of the related
options, generally four years. The Company recognized stock compensation
expense of approximately $1,372,000, $4,822,000 and $991,000 for the years
ended December 31, 2001, 2000 and 1999 respectively.
NOTE 8: INCOME TAXES
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets are as follows (in thousands):
December 31,
------------------
2001 2000
-------- --------
Net operating loss carryforwards...................... $ 15,582 $ 12,951
Capitalized startup and research and development costs 456 333
Research and development credit....................... 878 813
Other................................................. 1,021 421
-------- --------
Total deferred tax assets............................. 17,937 14,518
Less valuation allowance.............................. (17,937) (14,518)
-------- --------
$ -- $ --
======== ========
At December 31, 2001 the Company had federal and state net operating loss
carryforwards of approximately $42.7 million and $18.0 million respectively,
available to offset future taxable income. The Company's federal and state
operating loss carryforwards expire between 2010 and 2021 and between 2002 and
2006 respectively, if not utilized.
Due to the uncertainty surrounding the realization of the favorable tax
attributes in future tax returns, the Company has placed a valuation allowance
against its deferred tax assets. At such time as it is determined that it is
more likely than not that the deferred tax assets are realizable, the valuation
allowance will be reduced.
The Tax Reform Act of 1986 limits the use of net operating loss and tax
credit carryforwards in certain situations where changes occur in the stock
ownership of a company. In the event the Company has a change in ownership,
utilization of the carryforwards could be restricted.
52
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
NOTE 9: RELATED PARTY TRANSACTIONS
In August 1994, the Company entered into a cross-license agreement (the
"Agreement") with VIDAMed (a company whose founder was also one of the founders
of the Company) whereby the Company granted VIDAMed and exclusive royalty-free
license to use the Company's technology for certain applications. In return,
VIDAMed granted the Company an exclusive license to use VIDAMed's technology
for certain applications. The Company is required to pay a royalty of 2.5% of
net sales on products developed incorporating the VIDAMed technology. This
obligation terminates on the earlier of ten years from the effective date of
the Agreement or when payments by the Company to VIDAMed total $500,000. To
date the Company has made no payments under this agreement.
During 1999, the Company entered into a nonrecourse promissory note
arrangement with an officer and director of the Company. The full balance of
$72,888 plus accrued interest was repaid during 2000.
During 2000, the Company entered restricted stock purchase agreements and
related promissory note arrangements with five officers of the Company, one of
whom is also a director. The Company sold a total of 98,376 common shares to
these individuals at a price of $1.67 per share. Consideration was in the form
of signed, full recourse promissory notes bearing interest at the rate of 8%
compounded semiannually and collateralized by the common shares sold. The notes
will be forgiven at the rate of 25% of the loan amount on each January 1 from
2001 through 2004 for those individuals still employed with the Company. Any
unforgiven amounts will be due and payable on March 31, 2005 or immediately
upon an employee's termination from the Company. On January 1, 2001, 25% of the
loan amount was forgiven as scheduled. During 2001, two of the officers
terminated their employment with the Company; their unvested restricted shares
and related notes payable were cancelled as of their termination dates. At
December 31, 2001, at total of 54,936 restricted shares remained outstanding.
During the years 2001, 2000 and 1999, and from time to time prior to 1999,
the Company has received professional services relating to the administration
of its clinical trials from a firm in which one of the Company's directors
serves as an officer. The Company has recognized expenses relating to the
services received from this firm of approximately $109,000, $13,000 and $87,000
for the years ended December 31, 2001, 2000 and 1999 respectively.
NOTE 10: SEGMENT INFORMATION
The Company operates in one business segment. The Company sells its products
and systems directly to customers in the United States, Europe and Asia.
Sales for geographic regions reported below are based upon the customers'
locations. Following is a summary of the geographic information related to
revenues, long-lived assets and information related to significant customers
for the years ended December 31, 2001, 2000 and 1999 (in thousands, except
percentage data):
Years Ended December 31,
------------------------
2001 2000 1999
------- ------- ------
Sales:
United States........................ $ 8,032 $ 3,940 $1,669
Italy................................ 1,137 1,003 646
Japan................................ 1,879 2,924 1,420
Other................................ 3,743 2,143 894
------- ------- ------
Total............................. $14,791 $10,010 $4,629
======= ======= ======
53
RITA Medical Systems, Inc.
Notes to Financial Statements--(Continued)
Years Ended December 31,
------------------------
2001 2000 1999
------ ------ ----
Long-lived assets:
United States............................. $1,802 $1,054 $613
Europe.................................... 132 201 262
------ ------ ----
Total................................. $1,934 $1,255 $875
====== ====== ====
Years Ended
December 31,
-------------
2001 2000 1999
---- ---- ----
Significant customers: Revenue
Customer A.......................................... 14% 29% 41%
Customer B.......................................... 8% 10% 14%
December 31,
-----------
2001 2000
---- ----
Significant customers: Accounts Receivable
Customer A.............................................. 11% 22%
Customer B.............................................. 14% 16%
Customer C.............................................. 17% 14%
Customer D.............................................. 5% 4%
NOTE 11: EMPLOYEE BENEFIT PLAN
The Company sponsor's a 401(k) defined contribution plan covering all
employees. Contributions made by the Company are determined annually by the
board of directors. To date, there have been no company contributions to the
plan.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
The definitive proxy statement for our 2002 Annual Meeting of Stockholders,
when filed, pursuant to Regulation 14A of the Securities Exchange Act of 1934,
will be incorporated by reference into this Form 10-K pursuant to General
Instruction G (3) of Form 10-K and will provide the information required under
Part III (Items 10-13), except for the information with respect to our
executive officers, which is included in "Item 1. Business--Executive Officers
of the Registrant."
54
PART IV
Item 14.Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as part of this report:
(1) Financial Statements and Report of PricewaterhouseCoopers, LLP
Page
----
Report of Independent Accountants........................... 34
Consolidated Balance Sheets................................. 35
Consolidated Statements of Operations and Comprehensive Loss 36
Consolidated Statements of Stockholders' Equity (Deficit)... 37
Consolidated Statements of Cash Flows....................... 38
Notes to Consolidated Financial Statements.................. 39
(2) Exhibits are incorporated herein by reference or are filed in
accordance with item 601 of Regulation S-K.
Number Description
------ -----------
+2.1 Form of Agreement and Plan of Merger between the Registrant and RITA Medical Systems,
Inc., a Delaware corporation.
+3.2 Amended and Restated Certificate of Incorporation of RITA Medical Systems, Inc., a Delaware
corporation.
+3.4 Amended and Restated Bylaws of RITA Medical System, Inc.
++4.1 Preferred Shares Rights Agreement, dated as of July 31, 2001, between RITA Medical Systems,
Inc. and U.S. Stock Transfer Corporation, including the Certificate of Designation, the form
of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B and C,
respectively.
+10.1 Sixth Amended and Restated Shareholder Rights Agreement dated May 26, 2000 by and among
the Registrant and certain security holders.
+10.2 1994 Incentive Stock Plan (as amended) and form of option agreement.
+++10.3 2000 Stock Plan and form of option agreement.
#+++10.4 2000 Directors' Stock Option Plan and form of option agreement.
+10.5 2000 Employee Stock Purchase Plan and form of subscription agreement.
+10.6(a) Master Lease Agreement with Brown Mountain View Joint Venture dated July 12, 1994 and
extension of Master Lease Agreement dated May 12, 1999.
+10.7 Form of Indemnification Agreement between the Registrant and its officers and directors.
#+10.8 Employment Agreement with Barry Cheskin dated March 21, 1997.
#+10.9 Employment Agreement with Ronald Steckel dated May 26, 1998.
#+10.10 Employment Agreement with David Martin dated February 11, 2000.
#+10.11 Form of Change of Control Agreement entered into between the Company and it officers.
*+10.13 Distribution Agreement with Nissho Iwai Corporation (now named ITX Corporation) for South
Korea dated March 12, 1999.
*+10.15 Manufacturing Agreement with Plexus Corporation dated February 17, 2000.
*+10.16 Manufacturing Agreement with Apical Instruments, Inc. dated February 23, 2000.
55
Number Description
------ -----------
++++10.18* Amendment of Distribution Agreement with Nissho Iwai Corporation (now named
ITX Corporation) for Japan dated May 11, 2001.
**10.19 Distribution Agreement with MDH s.r.l. Forniture Ospedaliene for Italy dated December 31,
2001.
10.20 Separation Agreement with David Martin dated November 5, 2001.
10.21 Separation Agreement with Russell Johnson dated June 29, 2001.
10.22 Amendment to Master Lease Agreement with Brown Mountain View Joint Venture dated
June 4, 2001.
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants.
24.1 Power of Attorney (See Signature Page).
- --------
* Confidential treatment granted with respect to certain portions of this
Exhibit.
** Material has been omitted pursuant to a request for confidential
treatment and such material has been filed separately with the SEC.
+ Incorporated by reference to our registration statement on Form S-1 (File
No. 333-36160) initially filed with the SEC on May 3, 2000.
++ Incorporated by reference to our Registration Statement on Form 8-A (File
No. 000-30959) filed with the SEC on August 7, 2001.
+++ Incorporated by reference to our report on Form 10-Q (File No. 000-30959)
filed with the SEC on November 14, 2001.
++++ Incorporated by reference to our report on Form 10-Q (File No. 000-30959)
filed with the SEC on August 8, 2001.
# Management contract or compensatory plan or arrangement.
(b)No reports on Form 8-K were filed during the year ended December 31,
2001.
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Date: March 28, 2002 RITA MEDICAL SYSTEMS, INC.
By: /s/ BARRY CHESKIN
----------------------------------
Barry Cheskin
President, Chief Executive Officer
and Director
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Barry Cheskin and Donald Stewart, jointly and
severally, his or her attorneys-in-fact, each with the power of substitution,
for him or her in any and all capacities, to sign any amendments to this Report
on Form 10-K, and to file the same, with exhibits thereto and other documents
in connection therewith with the Securities and Exchange Commission, hereby
ratifying and confirming all that each of said attorneys-in-fact, or his or her
substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ BARRY CHESKIN President, Chief Executive March 28, 2002
- ----------------------------- Officer and Director
Barry Cheskin (Principal Executive Officer)
/s/ DONALD STEWART Chief Financial Officer and March 28, 2002
- ----------------------------- Vice President, Finance and
Donald Stewart Administration (Principal
Financial and Accounting
Officer)
/s/ VINCENT BUCCI Director March 28, 2002
- -----------------------------
Vincent Bucci
/s/ JANET EFFLAND Director March 28, 2002
- -----------------------------
JANET EFFLAND
/s/ JOHN GILBERT Director March 28, 2002
- -----------------------------
John Gilbert
/s/ SCOTT HALSTED Director March 28, 2002
- -----------------------------
Scott Halsted
/s/ GORDON RUSSELL Director March 28, 2002
- -----------------------------
Gordon Russell
57