Edgar Filing: RITA MEDICAL SYSTEMS INC

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2003

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 or organization)

(I.R.S. Employer

Identification No.)

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 ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨

As of July 31, 2003, there were 17,780,872 shares of the registrant’s Common Stock outstanding.

INDEX

		Page
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements (unaudited)

Condensed Consolidated Balance Sheets—June 30, 2003 and December 31, 2002		3

Condensed Consolidated Statements of Operations—three and six months ended June 30, 2003 and 2002		4

Condensed Consolidated Statements of Cash Flows—six months ended June 30, 2003 and 2002		5

Notes to Unaudited Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Conditions and Results of Operations		9

Item 3. Quantitative and Qualitative Disclosures About Market Risk		18

Item 4. Controls and Procedures		19

PART II. OTHER INFORMATION

Item 1. Legal Proceedings		20

Item 2. Changes in Securities and Use of Proceeds		20

Item 3. Defaults Upon Senior Securities		20

Item 4. Submission of Matters to a Vote of Security Holders		20

Item 5. Other Information		20

Item 6. Exhibits and Reports on Form 8-K		20

SIGNATURES		22

EXHIBIT INDEX		23

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PART 1. FINANCIAL INFORMATION

Item 1. Financial Statements

RITA MEDICAL SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share amounts, unaudited)

	June 30, 2003			December 31, 2002
Assets
Current assets:
Cash and cash equivalents	$	3,757		$	6,888
Marketable securities		7,329			5,427
Accounts and note receivable, net		2,966			2,798
Inventories, net		2,727			3,521
Prepaid assets and other current assets		663			995

Total current assets		17,442			19,629
Long term marketable securities		1,122			520
Long term note receivable, net		406			381
Property and equipment, net		1,419			1,565
Intangibles and other assets		5,142			2,071

Total assets	$	25,531		$	24,166


Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	442		$	1,053
Accrued liabilities		1,671			2,510

Total liabilities		2,113			3,563


Contingencies (Note 5)

Stockholders’ equity
Common stock		18			15
Additional paid-in capital		97,611			88,525
Stockholder notes receivable		—			(50	)
Accumulated other comprehensive income		7			7
Accumulated deficit		(74,218	)		(67,894	)

Total stockholders’ equity		23,418			20,603

Total liabilities and stockholders’ equity	$	25,531		$	24,166

The accompanying notes are an integral part of the condensed consolidated financial statements.

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RITA MEDICAL SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data, unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
Sales	$	4,049		$	4,806		$	8,546		$	9,224
Cost of goods sold		1,702			2,040			3,276			4,042

Gross profit		2,347			2,766			5,270			5,182


Operating expenses:
Research and development		1,061			1,329			2,419			2,663
Selling, general and administrative		4,736			5,304			9,300			10,527

Total operating expenses		5,797			6,633			11,719			13,190


Loss from operations		(3,450	)		(3,867	)		(6,449	)		(8,008	)

Interest income and other expense, net		50			134			125			282


Net loss	$	(3,400	)	$	(3,733	)	$	(6,324	)	$	(7,726	)


Net loss per share, basic and diluted	$	(0.19	)	$	(0.25	)	$	(0.36	)	$	(0.52	)


Shares used in computing net loss per share, basic and diluted		17,578			14,835			17,402			14,725

The accompanying notes are an integral part of the condensed consolidated financial statements.

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RITA MEDICAL SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands, unaudited)

	Six Months Ended June 30,
	2003			2002
Cash flows from operating activities:
Net loss	$	(6,324	)	$	(7,726	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		784			713
Revaluation of common stock warrants for services received		(42	)		62
Amortization of stock-based compensation		—			282
Allowance for doubtful accounts		55			591
Provision for obsolete inventories		247			479
Changes in operating assets and liabilities:
Accounts and note receivable		(316	)		(499	)
Inventories		547			(46	)
Prepaid and other current assets		332			438
Accounts payable and accrued liabilities		(1,450	)		219

Net cash used in operating activities		(6,167	)		(5,487	)


Cash flows from investing activities:
Purchase of property and equipment		(409	)		(566	)
Purchase of investments		(6,871	)		—
Sales and maturities of investments		4,367			3,963
Capitalization of patent litigation costs		(621	)		(771	)
Acquisition of intangibles		(2,650	)		—
Note receivable and other assets		68			3

Net cash provided by investing activities		(6,116	)		2,629


Cash flows from financing activities:
Proceeds from issuance of common stock		9,152			1,034
Payments on capital lease obligations		—			(118	)

Net cash provided by financing activities		9,152			916

Net decrease in cash and cash equivalents		(3,131	)		(1,942	)
Cash and cash equivalents at beginning of period		6,888			7,297

Cash and cash equivalents at end of period	$	3,757		$	5,355

The accompanying notes are an integral part of the condensed consolidated financial statements.

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RITA MEDICAL SYSTEMS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of presentation

The accompanying unaudited condensed consolidated 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, 2002 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 consolidated financial statements contain all adjustments (all of which are normal and recurring in nature, including the elimination of intercompany accounts) 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 unaudited condensed consolidated financial statements should be read in conjunction with the financial statements and footnotes thereto for the year ended December 31, 2002 contained in the Company’s annual report on Form 10-K.

2. Net loss per share

Basic earnings per share figures are 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 potentially dilutive securities consisting of stock options and warrants 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 weighted average outstanding common shares to shares used in determining net loss per share is as follows (in thousands):

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Weighted average shares of common stock outstanding	17,582		14,872		17,410		14,762
Less: weighted-average shares subject to repurchase	(4	)	(37	)	(8	)	(37	)

Weighted average shares used in basic and diluted net loss per share	17,578		14,835		17,402		14,725

The following numbers of shares represented by options and warrants (prior to application of the treasury stock method) and shares subject to repurchase were excluded from the computation of diluted net loss per share as their effect was antidilutive (in thousands):

	June 30,
	2003	2002
Effect of potentially dilutive securities:
Unvested common stock subject to repurchase	—	37
Options	2,182	2,639
Warrants	25	25

Total potentially dilutive securities excluded from the computation of net loss per share as their effect was antidilutive	2,207	2,701

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3. Balance sheet components—Inventories

The components of the Company’s inventories at June 30, 2003 and December 31, 2002, respectively, were as follows (in thousands):

	June 30, 2003		December 31, 2002
Raw materials	$	1,332	$	1,039
Work-in-process		36		341
Finished goods		1,359		2,141

	$	2,727	$	3,521

4. Accounting for stock-based compensation

During the year ended December 31, 2002, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” and Financial Accounting Standards Board Interpretations (“FIN”) No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.”

Under APB Opinion 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 following table illustrates the effect on net loss and net loss per share for the three and six month periods ended June 30, 2003 and 2002, respectively, if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation granted under all of the stock option plans and the Employee Stock Purchase Plan (in thousands, except per share amounts):

	Three months ended June 30,						Six months ended June 30,
	2003			2002			2003			2002
Net loss, as reported	$	(3,400	)	$	(3,733	)	$	(6,324	)	$	(7,726	)
Add: Stock-based employee compensation expense included in reported net loss		—			115			—			282
Deduct: Total stock-based employee compensation determined under fair value based method for all awards		(406	)		(632	)		(996	)		(1,238	)

Pro-forma net loss	$	(3,806	)	$	(4,250	)	$	(7,320	)	$	(8,682	)


Basic and diluted net loss per share:
As reported	$	(0.19	)	$	(0.25	)	$	(0.36	)	$	(0.52	)
Pro-forma	$	(0.22	)	$	(0.29	)	$	(0.42	)	$	(0.59	)

The determination of stock-based employee compensation under the fair value based method used the following weighted average assumptions:

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Volatility	76	%	79	%	76	%	79	%
Risk-free interest rate	2.69	%	4.56	%	2.73	%	4.41	%
Expected life	5 years		5 years		5 years		5 years
Expected dividends	0	%	0	%	0	%	0	%

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The corresponding assumptions for the Employee Stock Purchase Plan were as follows:

	Three months ended June 30,				Six months ended June 30,
	2003		2002		2003		2002
Volatility	70	%	79	%	70	%	79	%
Risk-free interest rate	1.49	%	4.56	%	1.63	%	4.41	%
Expected life	6 months		6 months		6 months		6 months
Expected dividends	0	%	0	%	0	%	0	%

5. Contingencies

From 1999 until April 2003, the Company was involved in patent-related disputes before the United States Patent and Trademark Office and the European Patent Office, as well as several patent infringement suits filed in the United States District Court for the Northern District of California. The principal parties in these matters were the Company, Boston Scientific Corporation and two of its operating divisions, RadioTherapeutics Corporation and Scimed Life Systems, Inc. Also included as adverse parties on particular matters were institutions or corporations from whom Boston Scientific has licensed technology, including the University of Nebraska, UneMed Corporation, the University of Kansas and the University of Kansas Medical Center Research Institute.

In April 2003, the Company announced that it had signed a definitive agreement with Boston Scientific, its affiliates and licensors to settle all outstanding patent disputes between the two companies. Under the terms of the agreement, all litigation in the United States, including Boston Scientific’s appeal of a United States Patent and Trademark Office ruling, has been dismissed with prejudice and Boston Scientific will withdraw its opposition before the European Patent Office. The Company was required to make one-time payments of $1,325,000 to the University of Kansas and $1,325,000 to the University of Nebraska, the licensors of several of the disputed patents. These amounts were capitalized in April 2003 and are being amortized over the related assets’ useful lives, which range from six to twelve years. The agreement includes a series of licenses and sub-licenses, none of which include the Company’s proprietary temperature control technology. The Company agreed to license to Boston Scientific, on a royalty-bearing basis, its infusion technology for future products. However, Boston Scientific will not market or sell products utilizing licensed infusion technology before October 5, 2004.

The Company may, from time to time, become a party to legal proceedings arising in the ordinary course of business. Such matters generally involve complex questions of fact and law and could involve significant costs and the diversion of resources to defend. Additionally, the results of litigation are inherently uncertain, and an adverse outcome is at least reasonably possible. The Company is unable to estimate the range of possible loss from such future litigation or other legal proceedings and no amounts have been provided for such matters in the accompanying unaudited condensed consolidated financial statements.

6. Comprehensive loss

Comprehensive loss generally represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. The Company’s unrealized gains and losses on available-for-sale securities represent the only components of comprehensive loss that are excluded from the Company’s net loss. These components are not significant individually, or in the aggregate, and therefore, no separate statement of comprehensive loss has been presented.

7. Private placement of securities

In January 2003, the Company issued to SF Capital Partners Ltd., Riverview Group, LLC, Baystar Capital II, L.P., and Baystar International II, L.P., 2,045,453 shares of unregistered common stock at a price of $4.40 per share, netting approximately $8.3 million after issuance fees and expenses. Wells Fargo Securities, LLC served as the lead placement agent for the transaction. The issuance was 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. On February 14, 2003, the Company’s Registration Statement on Form S-3, which registered the shares of common stock sold to the purchasers in the private placement transaction, was declared effective by the SEC.

8. Recent accounting pronouncements

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company does not believe adoption of this statement will materially impact its financial position or results of operations.

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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 quarterly report on 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 quarterly report on Form 10-Q and in our annual report on Form 10-K for the fiscal year ended December 31, 2002. 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. In 2001, we commercially launched our StarBurst XLi family of disposable devices and expanded our direct domestic sales organization and our international distribution network. In 2002, the XLi family of disposable devices gained acceptance in the United States. Also in 2002, we received regulatory approval from the FDA to use our products to treat pain associated with bone tumors, increasing the potential market for our products.

Our products are sold in the United States through our direct sales force and internationally through distribution partners. For the three months ended June 30, 2003, sales in the United States accounted for 81% of our total sales, compared to 73% in the prior year period, while sales in our international markets accounted for 19% of our total sales compared to 27% in the prior year period. We continue to expect domestic sales to account for the majority of total sales in future periods. Also, we expect that inventory reductions, particularly by our distributor in Japan, coupled with ongoing reimbursement issues in both Japan and Europe, to limit sales growth in these regions for at least the remainder of 2003. However, we expect our international operations to continue to represent a significant portion of our revenue 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 June 30, 2003, 87% of our sales were derived from our disposable devices and 13% were derived from the sale of our generators. Disposable product revenue for the quarter grew by 4% over the prior year period, primarily as a result of our expanded base of customer accounts, but generator revenue decreased by 62% as the prior year period included large generator shipments to our Japanese distributor. Going forward, 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, we expect revenue from the sale of our higher-margin disposable devices to grow faster than revenue from the sale of our generators.

To date, essentially all of our revenue has come from products sold in the treatment of cancerous liver tumors. In 2002, however, we began to see nominal revenue from the use of the RITA system sold for the treatment of patients with metastatic bone tumors. We are conducting research and clinical trials in other organs that may lead to additional sources of revenue in future years, although there can be no assurances that such additional revenue will materialize.

Our manufacturing costs consist of raw materials, including generators and ancillary hardware components 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 distributor discounts. Our gross margin for the three months ended June 30, 2003 was 58%, equal to our margin rate in the prior year period. Margins in the current period were pressured by the amortization of capitalized license fees associated with the settlement of our patent litigation dispute with Boston Scientific Corporation, described below, and we expect such amortization charges to continue for as long as twelve more years. Also, margins for the three months ended June 30, 2003, were limited by temporary cost increases, effective through June 2003, on some of our vendor-sourced hardware products and by significant provisions to our reserve for obsolete inventory. We have, from time to time, recognized relatively high expenses related to obsolete inventory provisions as our product line has undergone several changes, and we may experience pressure on margins in the future due to similar product changes. Despite these factors, we generally expect modest gross margin improvement over the balance of 2003 primarily as a result of improvements in our sales mix and manufacturing cost reductions.

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Our operating expenses consist of product development costs, clinical trial expenses, patent litigation expenses, sales and marketing expense related to our selling efforts in the United States and Europe, and administrative expenses, including the costs associated with our status as a public company, professional service expenses and our provisions for uncollectible accounts. Growth in these areas is determined by the breadth of our new product development portfolio, the number of headcount we maintain in our selling and administrative functions, the scope of our marketing efforts, the costs we incur in defense of our patents and intellectual property and the extent to which credit issues and economic conditions constrain our ability to collect our receivables. For the three months ended June 30, 2003, $1.1 million of our operating expenses were related to research and development activities, including $0.2 million associated with patent litigation expenses. For the prior year period, we had $1.3 million in research and development expense, including $0.1 million for litigation costs, so expenses for product development and clinical trials were lower for the three months ended June 30, 2003 than such expenses for the same period last year. We expect expenses for product development and clinical trials to remain stable throughout 2003, but ongoing legal expenses associated with patent litigation should be significantly reduced for the remainder of 2003 because we settled all of our outstanding patent disputes in April 2003. Total selling, general and administrative costs for the three months ended June 30, 2003, were $4.7 million compared with $5.3 million in the prior year period. This reduction primarily reflects $0.5 million in reduced expenses associated with provisions to our allowance for uncollectible accounts, with only minimal charges in the current period. Selling expenses for the current quarter were also modestly lower. Although the deterioration we experienced in international collections in 2002 has stabilized in 2003, we may encounter new difficulties with international collections that require further increases in our allowance for uncollectible accounts in the future, and we may require specific accounts to post letters of credit or pay in advance to minimize credit risk to the Company. Recent expense reduction efforts are expected to result in stable or modestly reduced levels of selling, general and administrative expense for the remainder of 2003.

From 1999 until April 2003, we were involved in patent related disputes before the United States Patent and Trademark Office, the European Patent Office and several patent infringement suits filed in the United States District Court for the Northern District of California. The principal parties in these matters were ourselves, Boston Scientific Corporation, two of its operating divisions and two of its licensors. In April 2003, we signed a definitive agreement with Boston Scientific, its affiliates and its licensors to settle all outstanding patent disputes. Under the terms of the agreement, litigation in the United States, including Boston Scientific’s appeal of a United States Patent and Trademark Office ruling, has been dismissed with prejudice and Boston Scientific will withdraw its opposition before the European Patent Office. We made one-time payments of $1,325,000 to the University of Kansas and $1,325,000 to the University of Nebraska, the licensors of several of the disputed patents. These amounts were capitalized in April 2003 and are being amortized over the related assets’ useful lives, which range from six to twelve years. The agreement includes a series of licenses and sub-licenses, none of which include our proprietary temperature control technology. We agreed to license to Boston Scientific, on a royalty-bearing basis, our infusion technology for future products. However, Boston Scientific will not market or sell products utilizing licensed infusion technology before October 5, 2004.

Our working capital decreased to $15.3 million at June 30, 2003, from $16.1 million at December 31, 2002. Since December 31, 2002, we have used $6.2 million in cash for operations, $0.4 million in capital expenditures and $0.6 million in capitalized legal costs related to defense of our patent rights. We also paid $2.65 million for licenses acquired in settlement of our patent litigation disputes with Boston Scientific Corporation. Offsetting these amounts were cash inflows of approximately $9.2 million from financing activities. Our January 2003 issuance of 2,045,453 shares of unregistered common stock at $4.40 per share netted approximately $8.3 million after associated fees and expenses, and the balance of the cash inflows from financing resulted from exercise of stock options. We do not expect significantly increased capital expenditures for the remainder of 2003.

We incurred net losses of $3.4 million for the three months ended June 30, 2003. As of June 30, 2003, we had an accumulated deficit of $74.2 million. Due to the costs associated with continued research and development programs, clinical research programs and sales and marketing efforts, we expect to incur net losses for the full year 2003, with diminishing losses through the year. Profitability depends 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.

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Critical Accounting Policies and Estimates

Our critical accounting policies and estimates were discussed in our annual report on Form 10-K for the fiscal year ended December 31, 2002. No changes in these policies and estimates have occurred during the six months ended June 30, 2003.

Results of Operations

The following table sets forth the percentage of net revenue represented by certain items in our Statements of Operations for the current quarter ended June 30, 2003 and the four preceding fiscal quarters:

	Q2 2003		Q1 2003		Q4 2002		Q3 2002		Q2 2002
Domestic sales	81	%	71	%	76	%	77	%	73	%
International sales	19	%	29	%	24	%	23	%	27	%

Total sales	100	%	100	%	100	%	100	%	100	%
Cost of goods sold	42	%	35	%	31	%	39	%	42	%

Gross profit	58	%	65	%	69	%	61	%	58	%


Operating Expenses:
Research and development	26	%	30	%	32	%	27	%	28	%
Selling, general and administrative	117	%	102	%	122	%	97	%	110	%

Total operating expenses	143	%	132	%	154	%	124	%	138	%

Loss from operations	(85	%)	(67	%)	(85	%)	(63	%)	(80	%)
Interest income and other expense, net	1	%	2	%	3	%	2	%	2	%

Net loss	(84	%)	(65	%)	(82	%)	(61	%)	(78	%)

Three months ended June 30, 2003 and 2002

Sales decreased 16% to $4.0 million for the quarter ended June 30, 2003, down from $4.8 million for the quarter ended June 30, 2002. Domestic sales decreased by 6% and international sales, due to large generator shipments to our distributor in Japan in the prior year period, decreased by 41% from the three months ended June 30, 2002. Sales of our disposable products totaled $3.5 million for the quarter, an increase of 4% over the comparable prior year period, reflecting modestly higher average selling prices in the domestic market, as unit shipments of disposable products decreased 2%. Generator sales for the quarter were 62% lower than sales in the second quarter of 2002, due again to the large generator shipments to our distributor in Japan in the prior year period.

Cost of goods sold for the quarter ended June 30, 2003 was $1.7 million compared to $2.0 million for the quarter ended June 30, 2002, resulting in 58% gross margin rates in both periods. Generally, we expect improvements in domestic and disposable product sales mix percentages to result in improved margin rates. However, in the current period, these trends were partially offset by the amortization of capitalized license fees associated with the settlement of our patent litigation dispute with Boston Scientific Corporation, and we expect such amortization charges to continue for as long as twelve more years. Also, margins were limited by temporary cost increases, effective through June 2003, on some of our vendor-sourced hardware products and by significant provisions to our reserve for obsolete inventory. We have, from time to time, recognized relatively high expenses related to obsolete inventory provisions as our product line has undergone several changes, and we may experience pressure on margins in the future due to similar product changes. Despite these factors, we generally expect modest gross margin improvement over the balance of 2003 primarily as a result of improvements in our sales mix and manufacturing cost reductions.

Research and development expenses for the quarter ended June 30, 2003 were $1.1 million compared to $1.3 million for the corresponding period in 2002, primarily because spending for product development and clinical trials decreased from year to year, although charges for patent litigation expense were also lower.

Selling, general and administrative expenses for the quarter ended June 30, 2003 were $4.7 million as compared to $5.3 million in the corresponding period in 2002. This reduction primarily reflects $0.5 million in lower expenses associated with provisions to our allowance for uncollectible accounts, with only minimal charges in the current period. Selling expenses for the current period were also modestly lower. Recent expense reduction efforts are expected to result in stable or modestly reduced levels of selling, general and administrative expense for the remainder of 2003.

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Interest income, net of interest and other expenses, was $50,000 for the quarter ended June 30, 2003, down from $134,000 in the corresponding period of 2002. The change was primarily attributable to a smaller portfolio of interest bearing securities, reflecting our use of cash over the past year, and lower interest rates.

Six months ended June 30, 2003 and 2002

Sales decreased 7% to $8.5 million for the six months ended June 30, 2003, down from $9.2 million for the six months ended June 30, 2002. For the six months ended June 30, 2003, domestic sales decreased by 3% and international sales, due to large generator shipments to our distributor in Japan in the prior year period, decreased by 41% from the six months ended June 30, 2002. Sales of our disposable products totaled $7.4 million for the year to date period, an increase of 12% over the prior year. This increase reflects modestly higher average selling prices in the domestic market, as unit shipments of disposable products decreased 4%. Generator sales for the six months ended June 30, 2003 were 57% lower than sales in the same period last year, due again to the large generator shipments to our distributor in Japan in the prior year period.

Cost of goods sold for the six months ended June 30, 2003 was $3.3 million compared to $4.0 million for the six months ended June 30, 2002, resulting in a 62% margin rate for the current year to date period, compared with a 56% rate in the comparable prior year period. Generally, we expect improvements in domestic and disposable product sales mix percentages to result in improved margin rates. However, in the current six month period, these trends were partially offset by the amortization of capitalized license fees associated with the settlement of our patent litigation dispute with Boston Scientific Corporation, and we expect such amortization charges to continue for as long as twelve more years. Also, margins were limited by temporary cost increases, effective through June 2003, on some of our vendor-sourced hardware products and by significant provisions to our reserve for obsolete inventory. We have, from time to time, recognized relatively high expenses related to obsolete inventory provisions as our product line has undergone several changes, and we may experience pressure on margins in the future due to similar product changes. Despite these factors, we generally expect modest gross margin improvement over the balance of 2003 primarily as a result of improvements in our sales mix and manufacturing cost reductions.

Research and development expenses for the six months ended June 30, 2003 were $2.4 million compared to $2.7 million for the corresponding period in 2002, primarily because spending for product development and clinical trials decreased from year to year, although charges for patent litigation expense were also lower.

Selling, general and administrative expenses for the six months ended June 30, 2003 were $9.3 million as compared to $10.5 million in the corresponding period in 2002. This reduction reflects $0.6 million in lower expenses associated with provisions to our allowance for uncollectible accounts, with only minimal charges in the current period. Also, our expenses for public relations and professional service charges were $0.3 million lower, and selling expenses were down by $0.3 million. We expect that recent expense reduction efforts will result in stable or modestly reduced levels of selling, general and administrative expenses for the remainder of 2003.

Interest income, net of interest expense and other expenses, was $125,000 for the six months ended June 30, 2003, down from $282,000 in the corresponding period of 2002. The change was primarily attributable to a smaller portfolio of interest bearing securities, reflecting our use of cash over the past year, and lower interest rates.

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. In January 2003, we completed a private placement of 2,045,453 common shares at a price of $4.40 per share, raising approximately $8.3 million net of expenses. As of June 30, 2003, we had $3.8 million of cash and cash equivalents, $8.5 million of short and long term marketable securities and $15.3 million of working capital. In April 2003, we paid a total of $2.65 million for licenses acquired in settlement of outstanding patent disputes, as required by the definitive agreement we reached with Boston Scientific Corporation, its affiliates and its licensors.

For the six months ended June 30, 2003, net cash used in operating activities was $6.2 million principally due to our net loss of $6.3 million offset by non-cash charges, including depreciation, amortization and provisions to reserves for uncollectible accounts and inventory, of $1.0 million. Approximately $0.9 million in cash was used by changes in working capital accounts, principally a $1.5 million reduction in accounts payable and accrued liabilities. Our investing activities for the six months ended June 30, 2003, were limited to the purchase of property and equipment in the amount of $0.4 million, capitalization of certain patent defense litigation costs in the amount of $0.6 million, and capitalization of intangibles associated with settlement of our

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patent litigation in the amount of $2.65 million. During the six months ended June 30, 2002, we invested, net of sales and maturities, approximately $2.5 million in short and long-term marketable debt securities. Financing activities for the six months ended June 30, 2003, provided $9.2 million in cash, all related to issuance of common shares through our January private placement or exercise of stock options.

As of June 30, 2003, future minimum payments due under operating leases were as follows (in thousands):

2003	$	267
2004		356

Total of future minimum operating lease payments	$	623

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, based on our cash-burn rate of approximately $1.0 million per month through the first half of 2003 and recently implemented expense reduction programs, we believe that our current cash and cash equivalents will satisfy our cash requirements for approximately 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.

Recent Accounting Pronouncements

In November 2002, the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We do not believe adoption of this statement will materially impact our financial position or results of operations.

Factors That May Affect Future Results

In addition to the other information in this quarterly report on Form 10-Q and in our annual report on form 10-K for the fiscal year ended December 31, 2002, the following factors should be considered carefully in evaluating our 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 have a history of losses and may never achieve profitability.

Although we believe that our operating expenses have stabilized in absolute dollars, to become profitable we must increase our sales and continue to manage our operating expenses. 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 $6.3 million in the six months ended June 30, 2003, $13.5 million in 2002, $13.0 million in 2001, $12.8 million in 2000 and $7.5 million in 1999. At June 30, 2003, we had an accumulated deficit of approximately $74.2 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. Furthermore, in April 2003, we entered into a license agreement with Boston Scientific, its affiliates and licensors, pursuant to which we granted Boston Scientific rights to manufacture and sell products using our infusion technology after October 5, 2004.

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As a result, Boston Scientific may develop and sell some competing products that would, in the absence of this license agreement, infringe our patents.

We are also aware of several companies in international markets which sell products that compete directly with ours. These companies are affecting our international market share and may erode that share in the future. In addition, one of these companies, Berchtold Corporation, has recently received FDA clearance for using 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 perceived to be 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 or that further short or long-term studies do not support the safety and efficacy of our products in various applications.

Our products are supported by clinical follow-up data in published clinical reports or scientific presentations covering periods from five months to three years after radiofrequency ablation. If additional studies in liver cancer or in other applications fail to confirm or demonstrate 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 retrospective, not randomized or included small patient populations and because, in certain circumstances, we rely on clinical data developed by independent third party physicians, our clinical data may not be reproduced in wider patient populations.

If we are unable to protect our intellectual property rights or if we are found to infringe the rights of others, we may lose market share to our competitors 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. That could result in lawsuits against us. Our pending United States and foreign patent applications may not issue or may issue and be subsequently successfully challenged by others. 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 on 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 expensive and time consuming and could divert 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 our competitors 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 increase 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 (for example, our distributor in Japan has built up a significant inventory of product in anticipation of the receipt of product and reimbursement approvals);

•

obtaining reimbursement for procedures using our devices in some foreign markets;

•

the burden of complying with complex and changing foreign regulatory requirements;

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•

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 significantly reduces its 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 30% of our international revenues in the six months ended June 30, 2003 and 55% of our international revenues in 2002. M.D.H. s.r.l. Forniture Ospedaliere, our distributor in Italy, accounted for 26% of our international revenues in the six months ended June 30, 2003 and 17% of our international revenues for 2002. Because international revenues accounted for 24% of our total revenues for the six months ended June 30, 2003 and these two distributors represented 56% of that total, the loss of either distributor or a significant decrease in unit purchases by either distributor could cause our 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. During the first quarter of 2003, we terminated our agreements with three of our international distributors and although we have contracted with replacement distributors we have expended significant time and resources in doing so. In addition, our near term sales in the three affected markets could suffer during the transition period that we estimate could last through September of 2003. If we or our distributors terminate other distributor agreements, we could incur similar or more burdensome expenses, have to expend significant time and resources in finding replacement distributors and our sales could decrease during any related transition period.

We are aware that some of our international distributors have built up inventory of our products. As a result, future sales to 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 which may also impact our revenue recognition policy on future distributor sales.

In recent quarters we have significantly increased our allowance for uncollectible accounts to address the risk associated with longer collection periods that have arisen principally with our European distributors. If difficult economic conditions persist, and our collection experience worsens as a result, we may need to further adjust our allowance for uncollectible accounts in future periods, thereby reducing profits.

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. For example, ITX Corporation, our distributor in Japan, is seeking 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 in foreign markets 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. Even though in February 2002 we were successful in establishing a new CPT code related to liver procedures with the American Medical Association, a third-party payor still may not reimburse adequately for the procedure or product. We are aware of cases in which reimbursement for liver procedures using our system has been denied. In addition,

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there is no specific reimbursement code for radiofrequency ablation of tumors 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. In addition, reimbursement levels are highest when our products are used in an inpatient setting. If there is a trend toward the use of our products on an outpatient basis, reimbursement levels could be lower and physician use could decline.

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 team, including our Chief Executive Officer and Chief Financial Officer, as well as key staff in the areas of finance, operations and research and development. Mr. Barry Cheskin, was our Chief Executive Officer from May 1997 until his resignation in April 2003. Our Chief Financial Officer, Mr. Donald Stewart, assumed interim responsibility for day-to-day operations at the Company until a permanent Chief Executive Officer was hired. Mr. Joseph DeVivo has agreed to become our new Chief Executive Officer, effective August 18, 2003. Our future success will depend in part on the continued service of our staff and our ability to identify, hire and retain additional personnel. The market for qualified management personnel in Northern California, where our offices are located, is competitive and is expected to remain so. Because the environment for good personnel is so competitive, costs related to compensation may increase significantly. If we are unable to attract and retain both the management team and key 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. Such use 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

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low. Any securities litigation claims brought against us could result in substantial expense and divert management’s attention from our core business.

We have limited experience manufacturing our disposable devices in substantial quantities, and if we are unable to hire sufficient additional personnel or to 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 and equip our manufacturing operations or are otherwise unable to meet customer demand for our products, our business could suffer.

We are dependent on two suppliers as the only sources of a component that we use in our disposable devices, and any disruption in the supply of this component could negatively affect our business.

Until recently, there has been only one supplier available to provide us with a component that we include in our disposable devices. During the quarter ended June 30, 2003, we qualified a second supplier. However, a disruption in the supply of this component is still possible and could negatively affect revenues. 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 two suppliers as our only sources of an accessory device used in conjunction with our Starburst XLi line of disposable devices, and any disruption in the supply of these devices could negatively affect our revenues.

Until December 2002, we had only one supplier available to provide us with accessory infusion pumps used in conjunction with our Starburst XLi line of disposable devices. During the quarters ended September 30, 2002 and December 31, 2002, we experienced shortages in the supply of accessory infusion pumps. In December 2002, we qualified a new accessory infusion pump from our existing supplier for which we now have approval from UL and conditional approval from TUV for use in the United States and Europe. Also in December 2002, we qualified a second supplier of an accessory infusion pump, although we have not yet shipped this product to our customers commercially. Although we were able to remedy this supply disruption, future disruptions in the supply of this component are still possible and, in that event, our business could suffer through lower revenues or higher costs. Additionally, we have limited experience with both the primary and alternative pump and if either pump fails to perform as desired, revenues could be negatively affected.

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.

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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. Obtaining this approval or clearance 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, or it may require us to recall previously sold products. In addition, we intend to request additional label indications, such as approvals or clearances for the ablation of tumors in additional organs, including lung, uterus 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. In addition, in the course of the FDA process leading to clearance or approval for a new indication, FDA may request an advisory panel meeting or meetings to discuss the clinical data, the appropriate study design or other criteria for clearance or approval. In the event that the advisory panel advises FDA that the clinical data are inadequate or the study design or other criteria are inappropriate, and FDA concurs, the FDA clearance or approval process could be lengthened and anticipated revenues from that new indication would be delayed.

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 10 percent of our outstanding common stock as of June 30, 2003, 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 merger or acquisition or other change of control that a stockholder may consider favorable.

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 or other change of control 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 for the year ended December 31, 2002, filed on March 28, 2003.

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Item 4. Controls and Procedures

Within 90 days prior to the date of this report on Form 10-Q, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures, as defined in Rules 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934. Based upon that evaluation, the principal executive officer and principal financial officer has concluded that the Company’s disclosure controls and procedures are effective. The Company’s disclosure controls and procedures are designed to provide a reasonable level of assurance of reaching its desired disclosure control objectives and are effective in doing so.

There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these internal controls subsequent to the date of their evaluation.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

From 1999 through March, 2003, the Company has been involved in patent-related disputes before the United States Patent and Trademark Office and the European Patent Office, as well as several patent infringement suits filed in the United States District Court for the Northern District of California. The principal parties in these matters were Boston Scientific Corporation and two of its operating divisions, RadioTherapeutics Corporation and Scimed Life Systems, Inc. Also included as adverse parties on particular matters were institutions or corporations from whom Boston Scientific has licensed technology, including the University of Nebraska, UneMed Corporation, the University of Kansas and the University of Kansas Medical Center Research Institute. These matters are described more fully in the Company’s annual report on Form 10-K for the year ended December 31, 2002.

In April 2003, the Company announced that it had signed a definitive agreement with Boston Scientific and its affiliates to settle all outstanding patent disputes between the two companies. Under the terms of the agreement, all litigation in the United States, including Boston Scientific’s appeal of a United States Patent and Trademark Office ruling, has been dismissed with prejudice and Boston Scientific will withdraw its opposition before the European Patent Office. The Company was required to make one-time payments of $1,325,000 to the University of Kansas and $1,325,000 to the University of Nebraska, the licensors of several of the disputed patents. These amounts were capitalized in April 2003 and are being amortized over the related assets’ useful lives, which range from six to twelve years. The agreement includes a series of licenses and sub-licenses, none of which include the Company’s proprietary temperature control technology. The Company agreed to license to Boston Scientific, on a royalty-bearing basis, its infusion technology for future products. However, Boston Scientific will not market or sell products utilizing licensed infusion technology before October 5, 2004.

The Company may, from time to time, become a party to legal proceedings arising in the ordinary course of business. Such matters generally involve complex questions of fact and law and could involve significant costs and the diversion of resources to defend. Additionally, the results of litigation are inherently uncertain, and an adverse outcome is at least reasonably possible. We are unable to estimate the range of possible loss from such future litigation or other legal proceedings and no amounts have been provided for such matters in the accompanying unaudited condensed consolidated financial statements.

Item 2. Changes in Securities and Use of Proceeds. Not applicable.

Item 3. Defaults Upon Senior Securities. Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders.

On June 26, 2003, the Annual Meeting of Stockholders of RITA Medical Systems, Inc. was held in Menlo Park, California.

An election of Class III directors was held with the following individuals being elected to our Board of Directors to serve until our annual meeting of stockholders for the year ending December 31, 2006:

Vincent Bucci		(10,906,475 votes in favor, no votes withheld, 14,388 votes abstaining)

Randy Lindholm		(10,906,475 votes in favor, no votes withheld, 14,388 votes abstaining)

F. Thomas (Jay) Watkins		(10,906,475 votes in favor, no votes withheld, 14,388 votes abstaining)

Other matters voted upon and approved at the meeting and the number of affirmations, negative votes cast and abstentions with respect to each such matter were as follows:

•

Ratification of the appointment of PricewaterhouseCoopers LLP as our independent accountants for the fiscal year ending December 31, 2003 (10,889,025 votes in favor, 31,043 votes opposed, 795 votes abstaining).

Item 5. Other Information. Not applicable.

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits:

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** 10.32		Litigation Settlement Agreement between the Company and RadioTherapeutics Corporation, Boston Scientific Corporation, Scimed Life Systems Inc., the Board of Regents of the University of Nebraska, University of Kansas d/b/a University of Kansas Medical Center and University of Kansas Medical Center Research Institute, Inc. effective as of April 4, 2003.

# 10.33		Form of Indemnification Agreement between the Company and Randy Lindholm on April 25, 2003 and between the Company and Lynn Saccoliti on May 1, 2003.

# 10.34		Consulting Agreement with Randy Lindholm dated April 25, 2003.

# 10.35		Amendment to offer letter to Donald Stewart dated as of May 1, 2003.

# 10.36		Offer letter to Lynn Saccoliti dated as of May 1, 2003.

31.1		Rule 13a-14(a) Section 302 Certification

32.1		Certificate pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Material has been omitted pursuant to a request for confidential treatment and such material has been filed separately with the SEC.

Management contract or compensatory plan or arrangement.

(b) Reports on Form 8-K:

A report on Form 8-K was filed with the SEC on April 7, 2003.

A report on Form 8-K was filed with the SEC on April 28, 2003.

A report on Form 8-K was filed with the SEC on April 29, 2003.

A report on Form 8-K was filed with the SEC on May 15, 2003.

A report on Form 8-K was filed with the SEC on July 7, 2003.

A report on Form 8-K was filed with the SEC on July 22, 2003.

A report on Form 8-K was filed with the SEC on July 31, 2003.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

RITA MEDICAL SYSTEMS, INC.

By:		/S/ DONALD STEWART
Donald Stewart Acting Chief Executive Officer, Chief Financial Officer and Vice President, Finance and Administration

Date: August 13, 2003

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EXHIBIT INDEX

** 10.32		Litigation Settlement Agreement between the Company and RadioTherapeutics Corporation, Boston Scientific Corporation, Scimed Life Systems Inc., the Board of Regents of the University of Nebraska, University of Kansas d/b/a University of Kansas Medical Center and University of Kansas Medical Center Research Institute, Inc. effective as of April 4, 2003.

# 10.33		Form of Indemnification Agreement between the Company and Randy Lindholm on April 25, 2003 and between the Company and Lynn Saccoliti on May 1, 2003.

# 10.34		Consulting Agreement with Randy Lindholm dated April 25, 2003.

# 10.35		Amendment to offer letter to Donald Stewart dated as of May 1, 2003.

# 10.36		Offer letter to Lynn Saccoliti dated as of May 1, 2003.

31.1		Rule 13a-14(a) Section 302 Certification

32.1		Certificate pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

Material has been omitted pursuant to a request for confidential treatment and such material has been filed separately with the SEC.

Management contract or compensatory plan or arrangement.

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