UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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
================================================================================
RITA MEDICAL SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3199149
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
967 N. Shoreline Blvd.
Mountain View, CA 94043
(Address of principal executive offices, including zip code)
650-314-3400
(Registrant's telephone number, including area code)
================================================================================
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes |X| No |_|
As of October 31, 2001, there were 14,532,954 shares of the
registrant's Common Stock outstanding.
INDEX
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Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited).
Condensed Balance Sheets - September 30, 2001 and 3
December 31, 2000
Condensed Statements of Operations - Three months and nine months 4
ended September 30, 2001 and 2000
Condensed Statements of Cash Flows - nine months 5
ended September 30, 2001 and 2000
Notes to Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and 8
Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 16
Item 2. Changes in Securities and Use of Proceeds. 17
Item 3. Defaults Upon Senior Securities. 17
Item 4. Submission of Matters to a Vote of Security Holders. 17
Item 5. Other Information. 17
Item 6. Exhibits and Reports on Form 8-K. 17
SIGNATURES 18
EXHIBIT INDEX 19
-2-
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
RITA MEDICAL SYSTEMS, INC.
CONDENSED BALANCE SHEETS
(In thousands, unaudited)
September 30, December 31,
2001 2000
---- ----
Assets
Current assets:
Cash and cash equivalents ....................................... $ 11,927 $ 12,676
Marketable securities ........................................... 15,027 27,381
Accounts receivable, net ........................................ 4,364 2,437
Inventories, net ................................................ 2,504 1,638
Prepaid assets and other current assets ......................... 1,111 823
------------ ----------
Total current assets ......................................... 34,933 44,955
Long term securities ................................................ 1,579 -
Property and equipment, net ......................................... 1,923 1,255
Intangibles and other assets ........................................ 144 60
------------ ----------
Total assets ................................................. $ 38,579 $ 46,270
============ ==========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable ................................................ $ 711 $ 425
Accrued liabilities ............................................. 1,979 1,895
Current portion of long term obligations ........................ 224 1,123
------------ ----------
Total current liabilities .................................... 2,914 3,443
Long term obligations .............................................. 42 180
------------ ----------
Total liabilities ............................................ 2,956 3,623
------------ ----------
Contingencies (Note 5)
Stockholders' equity
Common stock, $0.001 par value .................................. 15 14
Additional paid-in capital ...................................... 88,458 88,421
Deferred stock compensation ..................................... (2,208) (4,202)
Receivable from stockholders .................................... (97) (164)
Accumulated other comprehensive income .......................... 89 13
Accumulated deficit ............................................. (50,634) (41,435)
------------ ----------
Total stockholders' equity ................................... 35,623 42,647
------------ ----------
Total liabilities and stockholders' equity ................... $ 38,579 $ 46,270
============ ==========
See accompanying notes
-3-
RITA MEDICAL SYSTEMS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data, unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- -----------------------
2001 2000 2001 2000
---- ---- ---- ----
Sales ...................................................... $ 3,707 $ 2,712 $ 10,780 $ 6,980
Cost of goods sold ......................................... 1,472 1,622 4,912 4,298
--------- -------- --------- ---------
Gross profit ........................................ 2,235 1,090 5,868 2,682
--------- -------- --------- ---------
Operating expenses
Research and development ............................... 1,627 1,262 4,837 4,335
Selling, general and administrative .................... 4,016 3,023 11,539 8,347
--------- -------- --------- ---------
Total operating expenses ............................ 5,643 4,285 16,376 12,682
--------- -------- --------- ---------
Loss from operations ....................................... (3,408) (3,195) (10,508) (10,000)
Interest income and other expense, net ..................... 324 239 1,309 259
--------- -------- --------- ---------
Net loss ................................................... $ (3,084) $ (2,956) $ (9,199) $ (9,741)
========= ======== ========= =========
Net loss per share, basic and diluted ...................... $ (0.21) $ (0.31) $ (0.64) $ (2.47)
========= ======== ========= =========
Shares used in computing basic and diluted
net loss per share ......................................... 14,406 9,607 14,299 3,945
See accompanying notes
-4-
RITA MEDICAL SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
Nine Months Ended
September 30,
-------------------------
2001 2000
--------- -----------
Operating activities:
Net loss ................................................................................... $ (9,199) $ (9,741)
Adjustments to reconcile net loss to net cash used in operating activities: ................
Depreciation and amortization ....................................................... 704 784
Amortization of stock-based compensation ............................................ 1,417 4,022
Allowance for doubtful accounts ..................................................... 389 34
Allowance for inventory reserve ..................................................... 223 (28)
Changes in operating assets and liabilities
Accounts receivable ............................................................... (2,316) (1,159)
Inventory ......................................................................... (1,090) (586)
Prepaid and other current assets .................................................. (289) (421)
Accounts payable and accrued liabilities .......................................... 370 186
-------- --------
(9,791) (6,909)
Net cash used in operating activities .......................................... -------- --------
Cash flows from investing activities:
Purchase of property and equipment .................................................. (1,364) (344)
Purchases of short term investments ................................................. (15,087) (12,370)
Maturities of short term investments ................................................ 27,499 3,556
Purchases of long term investments .................................................. (1,560) -
Capitalization of patent litigation costs ........................................... (88) -
Other assets ........................................................................ 5 5
-------- --------
Net cash provided by (used in) investing activities ............................ 9,405 (9,153)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock .............................................. 682 38,998
Proceeds from borrowings of long term debt .......................................... - 1,500
Payments on long term debt .......................................................... - (3,000)
Proceeds from revolving term loan ................................................... 25 770
Payments on revolving term loan ..................................................... (858) (65)
Payments on capital lease obligations ............................................... (212) (124)
-------- --------
Net cash provided by (used in) financing activities ............................ (363) 38,079
-------- --------
Net increase (decrease) in cash and cash equivalents ...................................... (749) 22,017
Cash and cash equivalents at beginning of period .......................................... 12,676 7,067
-------- --------
Cash and cash equivalents at end of period ................................................ $ 11,927 $ 29,084
======== ========
See accompanying notes
-5-
RITA MEDICAL SYSTEMS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The accompanying unaudited condensed financial statements have been
prepared by RITA Medical Systems, Inc. (the "Company") in accordance with
accounting principles generally accepted in the United States of America for
interim financial information. These principles are consistent in all material
respects with those applied in the Company's financial statements contained in
the Company's annual report on Form 10-K for the fiscal year ended December 31,
2000 and pursuant to the instructions to Form 10-Q and Article 10 of Regulation
S-X promulgated by the Securities and Exchange Commission. However, interim
financial statements do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, the accompanying unaudited condensed
financial statements contain all adjustments (all of which are normal and
recurring in nature) necessary to present fairly the financial position, results
of operations and cash flows of the Company for the periods indicated. Interim
results of operations are not necessarily indicative of the results to be
expected for the full year or any other interim periods. These condensed
financial statements should be read in conjunction with the financial statements
and footnotes thereto for the year ended December 31, 2000 contained in the
Company's annual report on Form 10-K.
2. Net loss per share
Basic earnings (loss) per share figures are calculated based on the
weighted-average number of common shares outstanding during the period. Diluted
earnings (loss) per share figures include the dilutive effect of common stock
equivalents consisting of stock options, warrants, shares subject to repurchase
and shares issuable upon conversion of preferred stock provided that the
inclusion of such common stock equivalents is not antidilutive. For the three
and nine month periods ended September 30, 2001 and September 30, 2000, the
Company has excluded potentially dilutive securities from earnings per share
computations as they have an antidilutive effect due to the Company's net
losses. The following weighted options and warrants (prior to application of the
treasury stock method), convertible preferred shares (on an as-if-converted
method) and common shares subject to repurchase were so excluded (in thousands):
Three months ended Nine months ended
September 30, September 30,
------------- -------------
2001 2000 2001 2000
---- ---- ---- ----
Options and warrants ............................................ 2,438 2,139 2,358 2,071
Convertible preferred stock ..................................... - 3,011 - 6,945
Common shares subject to repurchase ............................. 61 98 69 77
------ ------ ------ ------
2,499 5,248 2,427 9,093
====== ====== ====== ======
The reconciliation of total outstanding common shares to shares used in
determining net loss per share is as follows (in thousands):
Three months ended Nine months ended
September 30, September 30,
------------- -------------
2001 2000 2001 2000
---- ---- ---- ----
Weighted average shares of common stock outstanding ............. 14,467 9,705 14,368 4,022
Less: weighted-average shares subject to repurchase ............ 61 98 69 77
------- ------ ------ ------
Weighted average shares used in basic and diluted
net loss per share ............................................ 14,406 9,607 3,945 14,299
======= ====== ====== ======
-6-
3. Inventories (in thousands)
September 30, December 31,
2001 2000
---- ----
Raw materials .............. $ 538 $ 404
Work-in-process ............ 283 203
Finished goods ............. 1,683 1,031
------ ------
$2,504 $1,638
====== ======
4. Recent Accounting Pronouncements
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.
5. Contingencies
The Company is involved in a patent interference proceeding with
RadioTherapeutics Corporation in which the validity of a patent issued to the
Company has been called into question. Although the Company believes it has
meritorious defenses, if it does not prevail in this interference, it could be
prevented from selling the RITA system or be required to pay license fees and /
or royalties on past and future product sales.
Also, 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. The
Company has to date capitalized approximately $88,000 in litigation costs
incurred in this defense of its patent positions.
-7-
Item 2. 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-Q 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-Q. 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.
Overview
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 2000, we commercially launched our Model 1500
generator and StarBurst 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 three months ended
September 30, 2001, sales in the United States accounted for 56% of our total
sales while sales in our international markets accounted for 44% of our total
sales. The percentage of our revenues from international markets has decreased
in 2001 as reimbursement concerns in Europe and Japan have slowed the growth of
our business in these markets and as our revenue in the United States has
responded to continued investment. We expect this trend to continue through the
balance of 2001 and 2002. Longer term, we expect that a significant portion of
our revenue will continue to come from international operations because of the
high incidence of primary liver cancer in Asian and European markets.
All of our revenue is derived from the sale of our disposable devices and
radiofrequency generators. For the three months ended September 30, 2001, 80% of
our sales were derived from our disposable devices and 20% were derived from the
sale of our generators. Placement of generators at hospitals is necessary for
customers to use our disposable devices, and we continue to focus on expanding
our base of customer accounts. We are also continuing to focus on increasing
usage of our disposable products at our established accounts, and we expect that
a significant proportion of our revenues will continue to be derived from the
sale of our higher-margin disposable devices.
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 and average selling prices. In
addition, margins are affected by the sales mix of disposable devices versus
generators, the mix of domestic direct sales versus international sales, which
provide for standard distributor discounts, and our regular provisions for
obsolete or excess inventory.
For the three months ended September 30, 2001, 29% of our operating
expenses were related to research and development activities, while 71% of our
operating expenses were related to selling, general and administrative
activities. We expect to continue to devote significant resources to product
development and clinical research programs. We also expect to continue to devote
the majority of our operating expenses to selling, general and administrative
activities, particularly to our sales and marketing efforts. These efforts
include the selective expansion of our domestic sales force and our
international distribution support activities as well as physician training and
patient awareness programs.
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 $0.4 million for the three months ended September 30, 2001. We
expect to record additional amortization expense for deferred compensation in
future periods.
We incurred net losses of $3.1 million for the three months ended September
30, 2001. As of September 30, 2001, we had an accumulated deficit of $50.6
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 continue to incur net losses for the balance
of 2001 and for the year 2002.
-8-
Our future growth depends on expanding product usage in our current market
and finding new large markets in which we can leverage our core technologies of
applying radiofrequency energy to treat cancerous and benign tumors. To the
extent our current or new markets do not materialize in accordance with our
expectations, our sales could be lower than expected.
On August 15, 2001 we filed a complaint against RadioTherapeutics
Corporation which alleges that the sale by RadioTherapeutics of its
radiofrequency ablation products infringes six of our patents. In addition, we
are currently involved in other patent disputes with RadioTherapeutics and may
become a party to additional patent or product liability proceedings in the
ordinary course of business. 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.
Results of Operations
Three months ended September 30, 2001 and 2000
Sales increased 37% to $3.7 million for the quarter ended September 30,
2001 from $2.7 million for the quarter ended September 30, 2000. We saw growth
in both domestic and international markets, with domestic sales increasing by
60% and international sales up by 15% over the comparable prior year period.
Sales of our disposable products totaled $3.0 million for the quarter, an
increase of 59% over the comparable prior year period. Higher unit shipments of
disposable products resulted from increased physician awareness of our
technology, expansion of our domestic sales force and increased geographical
representation through the appointment of new international distributors. Also,
average selling prices of disposable products benefited from the increasing
proportion of domestic business in our sales mix. Generator sales for the
quarter were 13% lower than sales in the third quarter of 2000.
Cost of goods sold for the quarter ended September 30, 2001 was $1.5
million compared to $1.6 million for the quarter ended September 30, 2000, a 9%
reduction. This reduction in cost of goods sold reflects a significant change in
our sales mix, from relatively high cost generators to relatively low cost
disposable products. Also, charges for amortization of deferred stock-based
compensation totaled $0.1 million for the third quarter of 2001, down from $0.2
million in the corresponding period of 2000. With sales up 37% and cost of goods
sold down 9%, the company's gross margin rate improved to 60% for the quarter
ended September 30, 2001 compared to 40% for the quarter ended September 30,
2000.
Research and development expenses for the quarter ended September 30, 2001
were $1.6 million compared to $1.3 million for the corresponding period in 2000.
This increase was attributable to new product development charges and increased
activity in clinical programs investigating new applications for our technology.
Charges to research and development expense for amortization of deferred
stock-based compensation were $0.1 million for the period compared to $0.2
million for the corresponding period in 2000.
Selling, general and administrative expenses for the quarter ended
September 30, 2001 were $4.0 million as compared to $3.0 million in the
corresponding period in 2000. The increase resulted from the major expansion of
our domestic sales organization and increased administrative expenses due to
added personnel to support our growth in operations. Charges to selling, general
and administrative expense for amortization of deferred stock-based compensation
were $0.2 million for the period compared to $0.6 million for the corresponding
period in 2000.
Interest income, net of interest expense, was $0.3 million for the quarter
ended September 30, 2001 compared to $0.2 million of net expense in the
corresponding period of 2000. The change 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.
Nine months ended September 30, 2001 and 2000
Sales increased 54% to $10.8 million for the nine months ended September
30, 2001 from $7.0 million for the nine months ended September 30, 2000. We saw
growth in both domestic and international markets, with domestic sales
increasing by 95% and international sales up by 28% over the comparable prior
year period. Sales of our disposable products totaled $8.3 million for the first
nine months of 2001, an increase of 85% over the comparable prior year period,
while generator sales were flat. Higher unit shipments of disposable products
resulted from increased physician awareness of our technology, expansion of our
domestic sales force and increased geographical representation through the
appointment of new international distributors. Also, average selling prices of
disposable products benefited from the increasing proportion of domestic
business in our sales mix.
Cost of goods sold for the nine months ended September 30, 2001 was $4.9
million compared to $4.3 million for the nine months ended September 30, 2000,
an increase of 14%. The growth in cost of goods sold was attributable primarily
to higher material, labor, and overhead costs associated with increased unit
shipments. Charges to cost of goods sold for amortization of deferred
stock-based compensation were $0.5 million for the period compared to $0.7
million for the corresponding period in
-9-
2000. With sales increasing by 54% and cost of goods sold increasing by only
14%, the company's gross margin rate improved to 54% for the nine months ended
September 30, 2001 compared to 38% for the nine months ended September 30, 2000.
Research and development expenses for the nine months ended September 30,
2001 were $4.8 million compared to $4.3 million for the corresponding period in
2000. This increase was attributable to new product development charges and
increased activity in clinical programs investigating new applications for our
technology. Charges to research and development expense for amortization of
deferred stock-based compensation were $0.3 million for the period compared to
$0.8 million for the corresponding period in 2000.
Selling, general and administrative expenses for the nine months ended
September 30, 2001 were $11.5 million compared to $8.3 million in the
corresponding period in 2000. The increase resulted from the major expansion of
our domestic sales organization, increased administrative expenses due to added
personnel to support our growth in operations and additional costs associated
with our operation as a public company. Charges to selling, general and
administrative expense for amortization of deferred stock-based compensation
were $0.6 million for the period compared to $2.5 million for the corresponding
period in 2000.
Interest income, net of interest expense, was $1.3 million for the nine
months ended September 30, 2001 compared to $0.3 million in the corresponding
period of 2000. The change 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.
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, of which there was $0.3 million in principal outstanding at September 30,
2001. As of September 30, 2001, we had $11.9 million of cash and cash
equivalents, $15.0 million of short term marketable securities, $1.6 million of
long term securities and $32.0 million of working capital.
For the nine months ended September 30, 2001, net cash used in operating
activities was $9.8 million, principally due to our net loss and increases in
accounts receivable. Our investing activities for this period were limited to
the purchase of property and equipment in the amount of $1.4 million and net
purchases or sales of both short-term and long-term investment instruments. Net
cash used by financing activities was $0.4 million in the first nine months of
2001 with $1.1 million in debt reduction offset by proceeds from the issuance of
common shares.
Our capital requirements depend on numerous factors including our research
and development expenditures, expenses related to selling, marketing and
administration as well as 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.
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 patent infringement, priority and validity disputes
with RadioTherapeutics Corporation, and if we do not prevail in these disputes,
we may be unable to sell the RITA system.
-10-
In August 2001, we filed a complaint against RadioTherapeutics Corporation
alleging that RadioTherapeutics' radiofrequency ablation products infringe six
of our patents. Our complaint seeks damages against RadioTherapeutics for its
sale of radiofrequency ablation products, including the LeVeen CoAccess
Electrode System and preliminary and permanent injunctive relief enjoining
RadioTherapeutics from further infringement of our patents. On October 17, 2001,
RadioTherapeutics filed an answer and affirmative defenses to our complaint
denying certain of the allegations in the complaint and asserting counterclaims
requesting declaratory relief that RadioTherapeutics is not infringing our
patents and that our asserted patents are invalid and unenforceable. While we
believe that our complaint has merit and that we have strong defenses against
the counterclaims made by RadioTherapeutics, we expect this litigation to be
expensive and time consuming and the outcome cannot be predicted.
In July 1999, the United States Patent and Trademark Office declared an
interference involving us, which was provoked by RadioTherapeutics, 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 the final confirmation of that decision in 2002. In the event that the
decision is confirmed, we plan to file a motion in a United States District
Court or the Court of Appeals for the Federal Circuit requesting review of the
decision. Final determination of both the patent infringement and the patent
interference proceedings may take several years. If the final determination in
either patent dispute results in our patents being declared invalid and the
issuance of the disputed patent rights to RadioTherapeutics and we were unable
to obtain a license to use the relevant patent or modify our disposable devices,
we could be unable to sell the RITA system and our business would suffer.
In March 2000, RadioTherapeutics 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. 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. 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. Historically, we have never shown a profit for any year or quarterly
reporting period, and our accumulated deficit stands at $50.6 million as of
September 30, 2001.
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 privately held company, and Radionics,
Inc., a division of Tyco Healthcare LP, a publicly traded company with
substantial resources. Both RadioTherapeutics and Radionics sell products that
use radiofrequency energy to ablate soft tissue. Boston Scientific Corporation,
a publicly traded company with substantially greater resources than we have, has
recently announced plans to acquire RadioTherapeutics.
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.
-11-
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.
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.
We are substantially dependent on two distributors in our international markets,
and if we lose either distributor or if either distributor reduces their product
demand, our international and total revenues could decline.
-12-
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 34 percent of our international
revenues for the nine months ended September 30, 2001 and 48 percent of our
international revenues in 2000. M.D.H. s.r.l. Forniture Ospedaliere, our
distributor in Italy, accounted for 18 percent of our international revenues for
the nine months ended September 30, 2001 and 17 percent of our international
revenues for 2000. Because international revenues accounted for 50 percent of
our total revenues for the nine months ended September 30, 2001 and these two
distributors represented 52 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.
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. Hospitals using our
products are currently reimbursed based on established general reimbursement
codes. Because there is no specific reimbursement code for physicians performing
procedures using the RITA system, physicians need to submit a patient case
history and data supporting the applicability of our system to the patient's
condition in order to obtain reimbursement. Each payor then determines whether
and to what extent to reimburse for a medical procedure or product. Payors may
refuse to provide reimbursement for procedures covered by general codes because
the applicability of the code must be determined on a case-by-case basis.
Although we have been notified by the American Medical Association Coding
Committee that specific reimbursement codes for radiofrequency ablation of liver
tumors will be established in 2002, 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 if we were successful in
establishing a new code, a payor still may not reimburse adequately for the
procedure or product. In addition, 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,
-13-
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 extremely competitive and is expected to continue to be
highly 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.
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.
-14-
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 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.
One third-party supplier currently manufactures, to our specifications, one
of the generators we sell. There is only one other third-party contractor who we
have used who could readily assume this manufacturing function. Two third-party
suppliers produce the other generator we sell. 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.
-15-
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.
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 3. Quantitative and Qualitative Disclosures About Market Risk
Our market risk disclosures have not changed significantly from those set
forth in Management's Discussion and Analysis of Financial Condition and Results
of Operations in our Form 10-K filing dated March 27, 2001.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
On August 27, 2001 we filed a complaint against RadioTherapeutics
Corporation in the United States District Court for the Northern District of
California. The principal parties in the proceeding are RadioTherapeutics and
RITA. The factual basis underlying the dispute is our claim that the sale by
RadioTherapeutics of its radiofrequency ablation products infringes six of our
patents. On October 17, 2001, RadioTherapeutics filed an answer and affirmative
defenses to our complaint denying certain of the allegations in the complaint
and asserting counterclaims requesting declaratory relief that RadioTherapeutics
is not infringing our patents and that our asserted patents are invalid and
unenforceable. RadioTherapeutics has also moved to stay the litigation pending
the outcome of the patent interference proceeding described below. Our complaint
seeks treble damages against RadioTherapeutics for its sale of radiofrequency
ablation products, as well as temporary and permanent injunctive relief
enjoining RadioTherapeutics from further infringement of our patents.
-16-
We are also involved in a patent interference proceeding before the Board
of Patent Appeals and Interferences of the United States Patent and Trademark
Office. On July 16, 1999 the United States Patent and Trademark Office declared
an interference between a claim of one of our issued patents and claims of a
patent application controlled by RadioTherapeutics. 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. 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.
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 2. Changes in Securities and Use of Proceeds
On August 1, 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. The
managing underwriters were Salomon Smith Barney and Robertson Stephens. We
intend to use 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. Additionally, we may use the proceeds of the offering
to fund the acquisition of complementary businesses, products or technologies,
although there are no current agreements or negotiations with respect to any
specific transaction.
As of September 30, 2001, we had applied $31.9 million of the $39.0 million
in net proceeds from our offering 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 $22.3
programs and general corporate purposes
------------------------------------------------------------------------
TOTAL: $31.9
------------------------------------------------------------------------
Item 3. Defaults Upon Senior Securities. Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders. Not applicable.
Item 5. Other Information. Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits: ** Exhibit 10.3: 2000 Stock Plan, as amended, and form
of option agreement
** Exhibit 10.4: 2000 Director's Stock Option Plan, as
amended, and form of option agreement
(b) Reports on Form 8-K: Not applicable.
** Supersedes previously filed exhibit.
-17-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RITA MEDICAL SYSTEMS, INC.
By: /s/ Donald Stewart
-------------------------------------
Donald Stewart
Chief Financial Officer and Vice
President, Finance and Administration
Date: November 14, 2001
-18-
EXHIBIT INDEX
-------------
** Exhibit 10.3: 2000 Stock Plan, as amended, and form of option agreement.
** Exhibit 10.4: 2000 Director's Stock Option Plan, as amended, and form of
option agreement
**Supersedes previously filed exhibit.
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