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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 3
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission File Number: 0-26082
VIDAMED, INC.
(Exact name of registrant as specified in its charter)
Delaware 77-0314454
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(State of incorporation) (IRS Employer Identification No.)
46107 Landing Parkway
Fremont, CA 94538
(Address of principal executive offices)
(510) 492-4900
(Registrant's telephone number)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of Class: Common Stock, $.001 par value
Preferred Share Purchase Rights
Indicate by check mark whether the registrant (1) has filed all reports
required by Section 13 of 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. [X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendments to this
Form 10-K. [ ]
The aggregate market value of the Common Stock of the registrant held by non-
affiliates as of August 13, 1999 was $37,439,543.
The number of outstanding shares of the registrant's Common Stock, $.001 par
value, was 20,650,603 as of August 13, 1999.
Documents incorporated by reference
Certain information is incorporated into Part III of this report by reference
to the Proxy Statement for the Registrant's 1999 annual meeting of stockholders
to be filed with the Securities and Exchange Commission pursuant to Regulation
14A not later than 120 days after the end of the fiscal year covered by this
Form 10-K/A.
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PART I
Item 1 - BUSINESS
Cautionary Statement Regarding Forward-Looking Statements
This report contains, in addition to historical information, forward-looking
statements that are based on current expectations and beliefs. Forward-looking
statements involve a number of risks and uncertainties that could cause actual
results to differ materially from those suggested in the forward looking
statements. Some of the factors that could cause actual results to differ
materially include, among others, market acceptance of the VidaMed Tuna
Procedure, availability of cash resources sufficient to fund operations,
availability and timing of third-party reimbursement for procedures performed
with the VidaMed Tuna System, the possible volatility of VidaMed's Stock Price,
and the risk factors discussed herein under "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and in the other
documents we file from time to time with the Securities Exchange Commission.
VidaMed undertakes no obligation to publicly revise these forward-looking
statements to reflect events or circumstances that arise after the date hereof.
General information
VidaMed, Inc. (the "Company" or "VidaMed") designs, develops, manufactures
and markets technologically and clinically advanced, cost effective systems for
urological conditions. Our focus is the treatment of the enlarged prostate or
benign prostatic hyperplasia (BPH). Our first product, the patented TUNA System,
is designed to offer a cost effective, minimally invasive alternative therapy
with compelling clinical advantages for BPH treatment. We commenced
manufacturing, production and international product sales in 1993. We received
clearance from the Food and Drug Administration (FDA) in October 1996, and
received Medicare CPT code # 53852, effective January 1, 1998, for the treatment
of symptoms associated with BPH. We sell our products primarily to urologists
and hospitals in the United States, and internationally to distributors who
resell to physicians and hospitals. Information about our revenues, operating
losses and assets is provided in the financial statements included in this
report - See Part II, Item 6, "Selected Financial Data" and Item 8, "Financial
Statements and Supplementary Data."
We were organized as a California corporation in July 1992 and were
reincorporated in Delaware in June 1995. Our principal offices are located at
46107 Landing Parkway, Fremont, California. Our telephone number is (510) 492-
4900.
Overview
The prostate is a fibromuscular gland that surrounds the urethra and lies
immediately below the bladder in the male. The normal prostate is approximately
the size of a walnut. The prostate gradually enlarges over a man's lifetime, a
condition known as begin prostatic hyperplasia ("BPH"). As the benign nodules
grow around the tube-like urethra, this growth obstructs the flow of urine
released from the bladder. As a result of BPH, men begin to experience problems
with urination which include:
. Decreased force of urinary stream;
. Frequency, the need to urinate more often, especially at night;
. Urgency, the sudden sensation that you need to find a toilet; and
. Incomplete emptying of the bladder.
A delay in treatment can have serious consequences, including complete
obstruction (acute retention of body waste or urine), urinary tract infections,
loss of bladder functions, and in extreme cases, kidney failure. The symptoms
can be debilitating and can significantly alter a sufferer's quality of life.
BPH is a very common condition among older men. According to industry
sources, the percentage of men suffering from symptoms of BPH is approximately
50% for men in their fifties and increases to more than 75% for men over eighty.
It is estimated that approximately 23 million men worldwide have urinary tract
problems associated with BPH, including approximately 14 million men in the
United States. Many patients experiencing BPH are regularly monitored and given
clinical tests by their physicians but, due in part to the side effects and
complications associated with current BPH therapies, elect not to receive active
intervention (a course of inaction known as watchful waiting). If symptoms
persist or worsen, drug therapy or surgical intervention is usually
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recommended. The most common surgical procedure is Transurethral Resection of
the Prostate (known as TURP), an invasive procedure in which portions of the
prostatic urethra and surrounding tissue are removed thereby widening the
urethral channel for urinary flow.
Prior to the advent of drug therapy in the mid-1990s TURP was the principal
method of treatment for BPH. Although the number of TURP procedures performed
in the United States has been declining progressively in recent years, TURP
remains one of the most common surgical procedures performed on men in the
United States and represents a major surgical expense reimbursed by Medicare. We
believe that the numerous complications associated with TURP and the acceptance
of drug therapy have lead to a decline in the number of TURP procedures
performed in the United States, from a total of 450,000 in 1992 to 150,000 in
1998.
Less invasive surgical procedures to treat the symptoms of BPH have been
developed. We feel that the development of less invasive procedures for the
treatment of BPH has developed from patients who fail drug therapy or otherwise
are looking for less radical alternatives than TURP or a lifetime on drug
therapy.
Total BPH related expenditures exceed $10 billion worldwide, approximately
$5 billion of which was spent in the United States. Industry sources estimate
that in excess of 1.5 million men currently receive medical treatment for BPH in
the United States. Industry sources estimate that approximately 450,000 BPH
patients outside the United States are currently receiving drug therapy, and
that approximately 550,000 TURP procedures are performed annually outside the
United States.
The BPH market is large and can be expected to continue to grow due to the
general aging of the world's population, as well as increasing life
expectancies. According to U.S. Census Bureau reports, the population of men 50
years of age and older in the United States is growing approximately 25%
annually and is expected to reach approximately 39 million in 2005. Improved
education on healthcare issues may also encourage more men to seek treatment of
their BPH symptoms.
Medicare, which covers approximately 80% of BPH patients in the U.S. is
under ever increasing budget pressures. The rising cost of healthcare in the
United States has also influenced public support for managed care in order to
control spending. Hospitals and doctors are now forced to compete for the
managed care dollars. We believe that we are well positioned to provide both
payors and physicians a cost-effective alternative to drug therapy, invasive
surgery, and other less invasive surgical procedures.
The TUNA System and Procedure
We have developed the TUNA System to provide the therapy of choice for BPH
over watchful waiting, drug therapy and current surgical therapies. Our TUNA
Procedure is designed to restore and improve urinary flow while resulting in
fewer complications and adverse effects, shorter recovery time and greater cost
effectiveness than other BPH therapies. We believe that the overall cost of
treatment with the TUNA Procedure will be less than the cost of most other
interventional BPH therapies because the procedure is designed to be performed
in an office or outpatient setting and to result in fewer complications.
The VidaMed TUNA System (VTS) is designed to deliver low levels of radio
frequency energy directly into prostate tissue to relieve the symptoms
associated with BPH. The principal components of the VTS PROVu TUNA System are:
VTS RF Generator, a low power radio frequency energy generator (Model
7600). The 7600 Model VTS Generator is designed specifically for use with the
PROVu cartridge, but is compatible with all previous models as well. This
computerized generator system is the control center for the TUNA Procedure. It
interprets and regulates the radio frequency energy delivered into each
prostatic lobe. In the automatic mode, the VTS Generator provides simultaneous
monitoring of urethral, prostatic and rectal temperatures to prevent damage to
the urethra, charring of prostate tissue and damage to the rectum. The manual
mode allows physicians to customize the lesion for optimal results in atypical
prostates. The VTS RF Generator continuously and automatically monitors the
procedure to reach the ideal treatment levels in each lobe of the prostrate.
The VTS Generator has an automatic shut-off activated by both temperature and
impedance measurements to ensure controlled tissue shrinkage. The integrated
computer records patient lesion information for medical records and
reimbursement.
VTS PROVu(TM) Cartridge, a single-use cartridge containing two needles
that extend at an approximate 90 degree angle from the cartridge's clear tip.
Each needle, which delivers radio frequency energy into the prostatic
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tissue, is equipped with a patented insulation shield to thermally protect the
urethra during the procedure. Within each shield is an apparatus that monitors
internal temperatures during the procedure.
VTS PROVu Reusable Handle, a device that attaches to the cartridge to
provide simultaneous needle deployment; and
VTS PROVu Telescope, an optical device designed to allow direct tissue
viewing and precise positioning of the cartridge during the procedure. A
unique feature of the PROVu Telescope and Handle is the ability to adjust the
scope forward or back during a procedure to view the placement of the needles
into the tissue. The PROVu Telescope meets the highest optical standards found
in the industry and is compatible with all major medical grade video camera
systems and light sources.
The TUNA Procedure shrinks targeted tissue in and surrounding the
prostrate, leading to improved urinary flow. It can generally be performed in
under an hour with local anesthesia such as lidocaine jelly and an oral
sedative. Some physicians also prefer to use a prostate block or intravenous
sedation. The VTS PROVu is inserted into the patient's urethra, and the two-
shielded needle electrodes are then advanced into one of the two lateral lobes
of the prostate. Controlled radio frequency energy delivered by the needle
electrodes heats targeted portions of the prostate lobe to temperatures of 90 to
100 degrees centigrade, creating a localized area of treated tissue measuring
approximately one to two centimeters in diameter, while the shields protect the
urethra from thermal damage. Once a lesion of sufficient size has been created,
the urologist retracts the needles and places the apparatus at the next site to
be treated and repeats the process. Typically, two or more treatments in each
lateral lobe of the prostrate are performed depending upon the size of the
prostate. If the patient is unable to urinate due to temporary swelling or
irritation of the urethra, a catheter may be inserted into the patient's
urethra. This catheter, if inserted, is typically left in place for one to three
days. Based on our randomized FDA audited trials as published in the May 1998,
Journal of Urology, there was an 8% incidence of post-procedure urinary tract
infection symptoms/urethral stricture resulting in a complete inability to
urinate, and a 32% incidence of post-procedure bleeding. There was no reported
incidence of impotence, retrograde ejaculation (the reverse flow of semen which
can result in sterility), or incontinence.
We believe that the TUNA System design offers significant advantages over
other BPH therapies. Because the components of the TUNA System shield the
urethra and deliver radio frequency energy directly into the interior of the
prostate, the procedure protects the prostatic urethra and reduces the risk of
unintended thermal damage to surrounding structures. In other procedures where
this control does not exist, the urethra and other structures can be damaged or
destroyed, causing significant patient discomfort and complications.
We believe that the cost of the TUNA procedure in the United States,
including physician charges, will be significantly less than the overall cost of
TURP due in large part to overnight hospital stays. The capital cost for our
TUNA System is less than the cost for microwave devices used for other minimally
invasive BPH procedures. A complete TUNA System has a list price of $80,000,
with a per procedure disposable cost of approximately $795. During the fourth
quarter of 1998, we introduced a fee per use program whereby we provide access
to TUNA Systems without requiring the purchase of the TUNA System, but charge a
fee of $2,639 for each TUNA Procedure performed.
In addition to providing procedural alternatives, we believe the VidaMed
TUNA Procedure also provides patients, physicians and health care payors with a
clinically and economically superior alternative to ongoing drug therapy. To
date, the symptomatic relief experienced by patients in our clinical trials
suggest that the TUNA procedure provides greater relief than the results
reported for drug therapy or watchful waiting. Additionally, our available
three-year U.S. clinical follow-up data and four-year international follow-up
data for TUNA patients do not suggest the need for a significant number of re-
treatments within these time frames. However, there can be no assurance as to
whether and how frequently TUNA patients will require retreatment.
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Alternative BPH Therapies
Watchful Waiting
The majority of BPH patients are initially managed through watchful
waiting, an approach entailing periodic visits to physicians and clinical
testing. The aim of watchful waiting is to monitor the patient's symptoms,
treat some of the attendant complications such as bladder infections, and
determine whether and when more active intervention is required. For many BPH
sufferers, watchful waiting represents only a temporary option due to generally
worsening symptoms that eventually require therapeutic intervention. We believe
that many health care payors have encouraged watchful waiting or drug therapy
over surgical intervention, due in large part to the higher costs of
interventional therapy, particularly TURP procedures.
Drug Therapy
Drug therapy for BPH has been available since the commercial availability
of four primary orally administered pharmaceutical products: Proscar (sold by
Merck KGaA) in 1992, Hytrin (sold by Abbott Laboratories) in 1993, Cardura (sold
by Pfizer Inc.) in 1995 and Flomax (sold by Boehringer Ingelheim
Pharmaceuticals, Inc.) in 1997. These remain the primary drug therapies
currently available although several other pharmaceutical products are currently
available or undergoing clinical trials for BPH symptom relief.
Proscar blocks hormones that stimulate growth of the prostate. Hytrin, an
alpha-blocker, disables alpha-receptors on smooth muscle cells in the area of
the prostate, causing muscle relaxation that alleviates some of the symptoms of
BPH. Cardura and Flomax, also alpha-blockers, act in a manner similar to
Hytrin. Side effects of alpha-blockers include dizziness, headache and fatigue.
Side effects of Proscar include impotence, decreased libido and other sexual
dysfunction Drug therapy generally must be administered daily for the duration
of the patient's life at an average annual cost of approximately $600 per year.
Surgical Treatments for BPH
Transurethral Resection of the Prostate. ("TURP"). TURP has been the
primary interventional treatment method for BPH since the 1940s and remains the
most common BPH surgical procedure. TURP is an inpatient procedure requiring
general anesthesia or regional anesthesia administered into the spinal column.
Patients usually remain in the hospital for 2-5 days and experience a 6-week
recovery period. The TURP procedure is performed by a physician, who uses a
visualization scope (known as a cystoscope) inserted through the urethra to view
the prostate and an electrically powered metal loop to remove a substantial
portion of the prostate. While TURP results in a dramatic improvement in urine
flow, it can also result in serious complications. A significant amount of
bleeding occurs during the procedure, and due to the trauma to the urethra,
patients may experience pain during urination and require the insertion of a
tube into the urethra to keep the urinary canal open, which tube is typically
left in place for several days or longer. The initial cost to the hospital of
the equipment needed to perform TURP, including a power source, cystoscope and
electrosurgical loop, is approximately $20,000, and this equipment is generally
reusable. The TURP procedure costs several thousands of dollars exclusive of
post-operative hospitalization.
A large number of TURP patients experience complications. Virtually all
patients experience a burning sensation upon urination that lasts for up to
three weeks following the procedure. Based on our randomized FDA audited trials
as published in the May 1998, Journal of Urology, other complications include:
. Impotence - 13% of patients;
. Retrograde ejaculation (the reverse flow of semen, which often results in
sterility) - 38% of patients;
. Post- Procedure Bleeding - 100%
. Urinary tract infection symptoms/urethral stricture resulting in a complete
inability to urinate - 20% of patients; and
. Incontinence - 4% of patients;
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According to the United States Department of Health and Human Services,
approximately 2% of TURP patients die as a result of the procedure and related
complications. At least 10% of TURP patients develop BPH symptoms again and
require retreatment within five years.
Transurethral Microwave Therapy (TUMT). The TUMT procedure is performed by
inserting an apparatus into the urethra to deliver microwave energy to destroy
prostatic tissue. TUMT is typically performed in an outpatient setting under
local anesthesia, which may be supplemented by intravenous sedation. Although
early experience with TUMT has demonstrated some success in alleviating the
symptoms of BPH, we believe the difficulty of controlling the absorption of
microwave energy in tissue may cause varying treatment outcomes. The primary
microwave treatments are discussed below:
. In 1996, a microwave system marketed by EDAP Techomed, Prostatron, received
FDA clearance for treatment of symptoms associated with BPH. Microwave
systems have been marketed in certain European countries for several years.
We believe the Prostatron generator is costs approximately $295,000, and per-
procedure disposable costs are estimated to be $600.
. In 1997, a U.S. based company, Urologix, received FDA clearance to market the
Targis System for the treatment of the symptoms associated with BPH. This
system has a capital equipment list price of $150,000 with a per procedure
disposable cost of about $1,200.
Both the EDAP Techomed and Targis systems are also sold as a mobile work
station on a turnkey, fee-per-use basis, generally costing $3,000 and higher.
Due to the design configurations of the microwave based systems, we believe
these systems limit the number of patients with BPH that can be treated. We
believe that the cost of the capital equipment and single-use disposable items
combined with the postoperative complications will limit the use of this
treatment method.
Interstitial Laser Coagulation. FDA cleared Johnson & Johnson's Indigo
LaserOptic(TM) Treatment System for U.S. marketing in December 1997. This
treatment uses a diode laser to directly view targeted tissue. Preliminary
studies indicate that treatment outcomes compare favorably to TURP in terms of
safety. Complications remains a concern with extended post-procedure
catheterization approaching 2 weeks and increased urinary tract infections in
some patients. Capital equipment costs approximately $50,000, and per procedure
disposable laser fibers are approximately $600.
Other Treatment Methods
Transurethral Vaporization of the Prostate (TVP). TVP is a variation of
TURP. It was introduced in January 1995 by Circon Corporation. TVP is
performed in a manner similar to using a paint roller and delivers electrical
energy to vaporize the urethra and prostate. It utilizes the same radio
frequency generator as does TURP, thus requiring no additional capital expense.
The TVP has similar efficacy as TURP with less bleeding and shorter post-
operative catheterization, but other complications are similar to those of TURP.
Transurethral Evaporization of the Prostate (TUEP). TUEP utilizes high
wattage laser energy at high power levels to cause evaporization of the
prostate. This procedure results in many of the same complications as TURP but
usually results in reduced blood loss. While clinical studies have indicated
that when properly performed, TUEP results in statistically significant
improvements for patients, the use of TUEP is generally limited due to its
prolonged operative time, requirement of general anesthesia, specialized
equipment, and cost. TUEP takes 25%-50% longer than a standard TURP.
High Intensity Focused Ultrasound (HIFU). High intensity focused
ultrasound (HIFU) uses a customized ultrasound probe to deliver precise high-
energy ultrasound (acoustic energy) to small-localized areas. This produces
high tissue temperatures and destroys target tissue. Clinical trials for HIFU
systems are currently underway in the United States and Japan. The procedure may
be performed in an outpatient setting under local anesthesia, but general
anesthesia may be required if the patient is unable to remain still during the
procedure. Additionally, HIFU is sub-optimal in-patients with large glands, and
is not recommended in the median lobe and for patients with multiple calcium
deposits. Early studies show that treatment outcomes are variable, and
complications include tissue sloughing that may require catheterization, and
blood in urine and seminal fluid. We believe that ultrasound systems used in
HIFU are currently being marketed at a price of approximately $100,000.
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Other procedures attempt to create an opening for urinary flow without
removing prostatic tissue. These procedures include transurethral incision of
prostate (TUIP), balloon dilation and stenting. Open surgery, in which the
entire prostate gland is removed, is often used as a treatment for prostate
cancer but is rarely used for treatment of BPH.
Marketing and Customers
We have positioned ourself for worldwide distribution of the TUNA System.
Our sales and marketing staff is located in the United States, United Kingdom
and Germany where direct distribution takes place. In the United States, we
market the TUNA System through a network of four regional sales managers
supported by both independent dealers and sales representatives.
Internationally, we primarily sell to distributors who resell to physicians and
hospitals.
Century Medical, Inc. paid a total of $1.0 million in 1995 and 1996, for
exclusive distribution rights in Japan for a period of five years commencing
with the receipt of Japanese regulatory approval for the TUNA System. In July
1997, the Japanese Ministry of Health and Welfare approved the VTS for sale and
a reimbursement level of 250,000 Yen for the procedure. We commenced shipments
to Century Medical at that time, and received an additional one-time $500,000
royalty. We believe that exclusive of the cost of drug therapy and
hospitalization fees, the annual cost of treating BPH in Japan is approximately
$80 million and that there are approximately 90,000 TURP procedures are being
performed each year in Japan.
Urologists around the world have adopted VidaMed's TUNA Procedure as a new
treatment for symptomatic BPH. Many of those urologists teach at prestigious
universities or are affiliated with leading hospitals. We believe that the
endorsements made by these early adopters will assist U.S. and worldwide
marketing efforts to create acceptance in the urological community. We will
continue to be represented at all major urology conferences in the United States
and the rest of the world. We have prepared a Physician Practice Building Kit
that contains a number of patient awareness and education materials for
urologists to use to expand their medical practice once their state Medical
Director activates the TUNA CPT payment code in their state.
We are committed to delivering a quality product to our customers and to
reinforce product delivery with excellent customer service and field support.
Clinical Status
We are performing clinical trials of the TUNA Procedure to obtain clinical
data to support new indications, to obtain long-term data, and to gather data in
supporting reimbursement approvals in various markets. We began international
clinical evaluation of the TUNA Procedure in March 1993 and U.S. trials in
November 1994. We are currently involved in clinical trials in Germany, France,
and Spain for reimbursement approval and acceptance within the medical
community. Multi-center studies in the U.S. are in progress to evaluate the
ProVu system in the treatment of the median lobe; an anesthesia study is ongoing
to scientifically document the treatment of TUNA in the office. Several
independent studies are ongoing to evaluate the TUNA procedure to support the
expansion of labeling claims, as to how the procedure is used.
In clinical trials conducted both in the United States and internationally,
the majority of TUNA patients for whom follow-up data is available show
significant relief from BPH symptoms. Follow-up data collected includes urine
flow rates and two standard measures of BPH symptom relief: (i) symptom score
and (ii) quality of life score. We believe the results to date indicate that the
TUNA System provides clinically significant relief from the symptoms associated
with BPH. These results are based on data published in peer-reviewed articles
and publications in top Urology journals on one-year follow-ups in the United
States. Scientific papers are currently being presented on U.S. two and three-
year data from these initial FDA trials. Three to four-year follow-up has been
published internationally.
In early 1999, the Blue Cross Blue Shield technical evaluation committee
reviewed the TUNA Procedure in multiple settings beyond clinical trials. Those
settings included TUNA Procedures performed in medical centers
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in the United States, Canada, Australia South Africa, Israel and Europe. The
committee evaluated the TUNA Procedure in light of the following five factors:
. The technology must have approval from the appropriate government regulatory
bodies;
. The scientific evidence must permit conclusions concerning the effect of the
technology on health outcomes;
. The technology must improve the net health outcome;
. The technology must be as beneficial as any established alternatives; and
. The improvement must be attainable outside the investigating settings.
The committee determined that the TUNA Procedure satisfied each of those
factors. We believe that the Blue Cross Blue Shield report provides further
support for the TUNA Procedure as a viable alternative to the TURP procedure.
Manufacturing
During 1998, we manufactured the new VTS PROVu reusable handle for
commercial sale at our facility in Fremont, California. At various assembly
stages, each production lot was thoroughly tested by trained personnel to ensure
compliance with our stringent specifications. Our quality assurance group
independently verified, at various steps in the manufacturing cycle, that
product fabrication and inspection processes met our specifications and
applicable regulatory requirements.
In 1998, we completed ISO 9001 certification at the Fremont facility and
obtained the necessary CE Mark (European authorization) for the ongoing sale of
our products in Europe.
Also during the year, we successfully completed a U.S. FDA/State of
California regulatory audit, which resulted in us obtaining a license to
manufacture our product in Fremont.
We contract with Telo Electronics aka Sanmina MPD to manufacture the VTS
Generator, and with Karl Storz in Germany to manufacture our VTS PROVu
Telescope. In January 1999, we began transitioning the manufacturing of our
disposable cartridge to Zeiss Humphrey Systems. Both Telo Electronics and Zeiss
Humphrey Systems are located in the Silicon Valley area.
Research and Development
Our research and development efforts are currently focused on improving the
features and reducing both the cost of the TUNA System and the time it takes to
perform a TUNA Procedure. Ongoing research and development efforts include
increasing the range of energy output of the radio frequency generator,
providing support for clinical trials, working with physicians to develop
product enhancements and developing devices for urological applications in
addition to BPH. Our in-house research and development program uses a network
linking computer assisted design and manufacturing capability and advanced
graphic design workstations with a computerized machine shop. These
capabilities allow us to produce molds, custom parts and tooling, enabling rapid
prototyping and pre-production evaluation of devices. We have fully funded all
research and development. The amounts expensed, in thousands, for 1996, 1997
and 1998 respectively are $5,742, $6,003 and $4,241.
Backlog
We do not have a backlog of orders for our products in countries where the
TUNA System is sold and anticipate that we will continue to ship orders after
their receipt. Accordingly, we do not anticipate that we will develop a
significant backlog in the future.
Patents, Trademarks and Licenses
We have been issued 42 United States patents and 40 foreign patents
covering a method of prostate ablation using the TUNA System and the design of
the TUNA System. The earliest termination date of any of our United States
patents is in 2009, with the majority of patents scheduled to continue in effect
through the year 2013.
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At the end of fiscal 1998, we had 16 patent applications pending in the United
States and 49 corresponding patent applications pending in various foreign
countries. Our patents focus on methods for delivery of low power radio
frequency energy to the prostrate for the treatment of BPH. We also have rights
to technology with allows our products to deliver radio frequency energy to
other organs of the human body while protecting surrounding tissue Our patents
materially support our place in the market by preventing others from making,
using, or selling devices which copy our treatment methods and equipment. It is
our policy to pursue aggressively protection of our patents.
We also enter into patent and technology licensing agreements with others
when management determines it in the Company's best interest to do so. We pay
royalties under existing patent license agreements for the use of patents in
certain of our products, which patents are licensed for the life of the patents.
We own various trademarks that we use in our business. These assets are
valuable to us, the most important of which are "TUNA", and our "V device"
corporate logo.
There can be no assurance that our issued United States patents, or any
patents which may be issued as a result of our applications, will offer any
degree of protection. There can be no assurance that any of our patents or
patent applications will not be challenged, invalidated or circumvented in the
future. In addition, there can be no assurance that competitors, many of which
have substantial resources and have made substantial investments in competing
technologies, will not seek to apply for and obtain patents that will prevent,
limit or interfere with our ability to make, use or sell our products either in
the United States or in international markets.
We have been and may in the future be notified that the Company may be
infringing the patents or other proprietary rights of others. If infringement
is established, we could be required to pay damages and be enjoined from selling
the infringing products or practicing processes. Moreover, if we were unable to
alter our products or processes to avoid the infringement claim, we might be
required to obtain licenses and there can be no assurance that necessary
licenses could be obtained on satisfactory terms, if at all. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Factors Affecting Results of Operations" - "Uncertainty Regarding Patents and
Protection of Proprietary Technology."
Employees
As of December 31, 1998, we employed 88 individuals on a full-time basis.
Of these, 84 were located in the United States, 3 in the United Kingdom and 1 in
Germany. We also have several part-time employees and consultants. Our
employees in Europe are covered under standard country services agreements
providing severance pay of one to three months in the event of termination of
employment without cause. None of our employees is covered under collective
bargaining agreements. We consider relations with our employees to be good.
With the outsourcing of manufacturing, the headcount has been reduced to 68 as
of February 1, 1999.
PART II
Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion of VidaMed's financial condition and results of
operations should be read in conjunction with the Consolidated Financial
Statements, the related Notes included in this report on Form 10-K/A, and the
Cautionary Statements Regarding Forward-Looking Statements presented at the
beginning of Part I of this Form 10-K/A.
Overview
Since our inception in July 1992, we have been engaged in the design,
development, clinical testing and manufacture of the VidaMed TUNA System for the
treatment of symptoms associated with BPH. We commenced international sales of
the TUNA System in late 1993 and United States sales in October 1996. Revenues
for the years ended December 31, 1998, 1997 and 1996 include license fees for
distribution rights in Japan. For the fiscal year ended December 31, 1998, we
marketed the TUNA System in the United States through a network of four sales
managers, supported by both sales representatives and independent dealers. In
Europe, Asia and South America, we marketed our products primarily through a
network of distributors who were supported by our staff.
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At the beginning of fiscal 1999, we began restructuring our sales and
marketing model to shift the emphasis from the sale of the TUNA System itself to
a model based on generating revenues through a fee-per-use program. Under the
prior model, we focused on selling the TUNA System generator and related
equipment to hospitals. Under the new sales model, an entire TUNA System is
placed with a hospital at no capital charge and a fee is charged for each
procedure performed.
We received FDA clearance to market the TUNA System in 1996, and in 1998,
Medicare reimbursement coverage became available for procedures using our
equipment that are performed in hospitals. As of August 15, 1999, 38 states
provide such reimbursement coverage. To achieve significant increases in sales,
we must actively promote the fee-per-use program and secure Medicare
reimbursement coverage at least in all states with large populations of men over
50 years of age, which is our target patient population. Medicare coverage for
supplies and devices in the office-based and ASC markets was delayed in mid-1998
due to Medicare's review of its "Year 2000" compliance. We believe that
Medicare reimbursement coverage in doctors' offices and ASCs, as well as patient
awareness and physician advocacy of the TUNA System and procedure, are our
greatest challenges. Our business strategy is to focus marketing and sales
efforts on patient education and physician support for our fee-per-use program
while at the same time continue to advance Medicare reimbursement coverage for
the TUNA Procedure, but, as discussed below in "Liquidity and Capital
Resources," we will not be able to do so without additional debt or equity
financing.
We do not anticipate reaching profitability in the near future. We expect
our operating losses to continue as we continue to commit substantial resources
to expand marketing and sales activities, fund clinical trials in support of
regulatory and reimbursement approvals, and fund research and development. Our
future profitability will be dependent upon, among other factors, market
acceptance of the VidaMed TUNA Procedure, availability and timing of third-party
reimbursement for procedures performed with the TUNA System, adoption of our
fee-per-use program and our ability to fund operations absent sufficient sales
of our products.
There can be no assurance that the TUNA System will be deemed clinically or
cost effective by health care providers and payors, superior to other current
and emerging methods for treating BPH, or that the TUNA System will achieve
significant market acceptance in the United States. Furthermore, determinations
of reimbursement of the TUNA Procedure by private and governmental health payors
are made by such payors and their medical directors independent of the FDA
approval. Accordingly, there can be no assurance that the TUNA Procedure will
be reimbursed at adequate levels in the United States under either private or
governmental healthcare payment systems. Availability of Medicare reimbursement
for the TUNA Procedure may be dependent on the publication of clinical data
relating to the cost-effectiveness and duration of the TUNA therapy. Inadequate
reimbursement for the TUNA Procedure could adversely effect market acceptance of
the TUNA System. Failure of the TUNA Procedure to achieve market acceptance in
the United States, lack of adequate funding, the impact of competitive products
and pricing and other risks could have a material adverse effect on our
business, financial condition and results of operations.
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Results of Operations
Net revenues for 1998 of $1.0 million decreased $8.8 million or 90% from
$9.8 million in 1997. Revenues in 1997 increased 157% from $3.8 million in
1996. Adjusting for the impact of the delay in office-based Medicare
reimbursement, we increased sales reserves by $2.7 million in the third quarter
of 1998 so that net revenues for the year were $1.0 million. Excluding the
sales reserve, revenues were $3.7 million in 1998, a decrease of $6.1 million or
62% from $9.8 million in 1997. Of that $6.1 million, approximately $1.5 million
is due to license fees and an initial stocking order received in 1997 from our
Japanese distributor following Japanese approval of the TUNA System. Another
$920,000 is due to an overall high sales volume in early 1997 to satisfy pent-up
demand following the 1996 FDA approval of the TUNA System, including a sale of
39 systems to Tenet HealthCare Systems in the first quarter of 1997. The
Company attributes the remaining differential to:
. increased domestic office sales (as opposed to hospital sales) of the TUNA
System in 1997 in anticipation of the purchase of TUNA Systems being
Medicare reimbursable as a result of our CPT Code becoming effective on
January 1, 1998; and
. the difficulties experienced in 1998 obtaining Medicare reimbursement
coverage for TUNA Systems sold and TUNA Procedures performed in states
which have not yet approved Medicare coverage for the TUNA System.
The sales reserve is a direct result of sales efforts in the office-based
and Ambulatory Surgery Center (ASC) markets, where our TUNA System is uniquely
suited, not providing the anticipated return due to the difficulties of Medicare
reimbursement coverage discussed above. Medicare coverage for supplies and
devices in the office-based and ASC markets was delayed in mid-1998 due to
Medicare announced Y2K problems. The ASC reimbursement program, which was
expected to be effective January 1, 1999, is now unlikely to go into effect
before mid-2000. As a result of Medicare reimbursement coverage delays, we
established the third quarter 1998 reserve for all office-based and ASC sales.
Current Medicare reimbursement coverage for the TUNA hand piece, related
equipment and supplies extends only to procedures performed in a hospital.
Reimbursement follows the "reasonable cost basis" method, whereby the hospital
is reimbursed for its fully burdened costs for treating Medicare patients. As
stated above, Medicare coverage for supplies and devices in the office-based and
ASC markets is not expected to be effective in the near future. The failure to
receive Medicare reimbursement coverage at the ASC level in the year 2000 could
have a material adverse affect on our future revenues.
We began 1998 with Medicare reimbursement coverage available for hospital
based procedures under CPT code 53852 in 4 states comprising 2% of the men over
50 years of age (TUNA's target patient population). By the 4th quarter of 1998,
this expanded to 14 states, covering 17% of men over 50. While this has
increased to 29 states and 51% of the over 50 male population in January 1999,
including California and Florida, to achieve significant increases in sales
volume, it may be necessary to obtain Medicare reimbursement coverage in all 50
states, or at least in all states with significant population centers,
particularly since sales agreements with major healthcare providers are often on
a national, or system-wide, basis. We have several initiatives underway to
facilitate the Medicare reimbursement approval process. We are working in
cooperation with state Medicare Medical Directors and important technical
bodies, such as the Blue Shield Technical Evaluation Committee, as well as
ongoing publication of our long-term clinical studies. There can be no assurance
that we will receive additional Medicare reimbursement coverage in major states
in a timely manner, and the failure to receive such coverage would have a
material adverse effect on our business, financial condition and results of
operations.
The increase in net revenues and product sales between 1997 and 1996 was
the result of United States sales of the TUNA System (VTS) Generator and Hand
Piece. Of the $9.8 million in 1997 revenues, $8.0 million was attributable to
U.S. product sales. Of the $3.8 million in 1996 revenues, $2.7 million was
attributed to U. S. product sales, primarily in the fourth quarter following FDA
clearance.
Cost of product sold in 1998 decreased to $3.1 million from $7.3 million in
1997. Cost of product sold in 1997 increased to $7.3 million from $3.7 million
in 1996. Cost of product sold for 1997 includes a one-time charge of $2.1
million related to the closure of our manufacturing facility in the United
Kingdom. The increase in 1997 is due primarily to an increase in product sales.
Due to the lower sales in 1998, gross margin was negative $2.1 in 1998. Gross
margin was positive $2.6 million in 1997 as a result of higher product sales. In
1996, the gross margin
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was relatively flat at a positive $145,000 due in part to high start-up costs
and low sales with FDA approval late in the year.
Research and development expenses (R&D) include expenditures for regulatory
compliance and clinical trials. Clinical trial costs consist largely of
payments to clinical investigators, product for clinical trials, and costs
associated with initiating and monitoring clinical trials. R&D expenses
decreased 29% to $4.2 million in 1998 from $6.0 million in 1997, and increased
5% in 1997 from $5.7 million in 1996. The difference from the year ended 1998 to
1997, is primarily due to:
. Investment in 1997 in development efforts on the TUNA System radio frequency
generator;
. Cost savings from the closure of the facility in the United Kingdom in 1997;
and
. Reduction of clinical trial costs.
The increase in 1997 when compared to 1996, is primarily due to the completion
of the TUNA System disposable product development in 1997.
Selling, general and administrative (SG&A) expenses increased 3% to $13.5
million in 1998 from $13.0 million in 1997, and 65% from $7.9 million in 1996.
The increase in 1998 from 1997 was due primarily to the transition to a new
chief executive officer and a realignment of our critical sales positions with
the addition of a new executive vice president of worldwide sales and marketing.
Spending in SG&A in both periods included start-up and launch costs for the
latest product releases and costs associated with the continued efforts to
support domestic and international sales and costs to secure global
reimbursement for the TUNA Procedure. During 1998, costs were incurred to
enhance the existing sales and field reimbursement force. Costs incurred in
1997, including a co-op advertising agreement with Tenet Health System remain
accrued (approximately $309,000) and available for programs at the individual
Tenet hospitals as Medicare reimbursement is approved in the state where the
Tenet hospitals are located. The increase in 1997 over 1996 is primarily due to
increased sales and marketing expense incurred in the continuing product
introduction of the TUNA System in the U.S. Significant sales and marketing
expenses included commissions, advertising expenses, trade shows and physician
workshops.
Interest and other income increased to $523,000 in 1998 from $345,000 in
1997, and decreased from $659,000 when compared to 1996. The increase in 1998 is
a result of increased investment balances from proceeds from private placements
of our common stock in 1998 and 1997. The decrease in 1997 is due to lower
investment balances as we used the capital raised during our initial public
offering in 1995. Interest and other expense increased in 1998 to $587,000 from
$359,000 in 1997, due to the addition of the bank line, the revolving credit
line and the equipment term loan. The decrease in 1997, from $715,000 in 1996,
was due to lower interest expense as a result of lower notes payable and capital
lease balances.
Our results of operations have fluctuated in the past and may fluctuate in
the future from year to year as well as from quarter to quarter. Revenues may
fluctuate as a result of several factors, including:
. Actions relating to regulatory and reimbursement matters;
. Results of clinical trials;
. The extent to which the TUNA System gains market acceptance;
. Varying pricing promotions;
. Volume discounts to customers; and
. Introduction of new products and the competitive introduction of alternative
therapies for BPH.
Operating expenses may fluctuate as a result of several factors, including:
. The timing of expansion of sales and marketing activities;
. Costs of clinical activities; and
. R&D and SG&A expenses associated with the potential growth of our
organization.
Fluctuations in operating results could have a material adverse affect on our
business by, among other things, disrupting our cash flow, limiting our ability
to attract investors, and impairing our ability to implement long range plans.
As a result, there can be no assurance as to when or whether we will achieve
profitability. If profitability is achieved, there can be no assurance such
profitability will continue in the future.
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Liquidity and Capital Resources
As we began fiscal 1999, we believed that our current cash balances, projected
cash flows from operations including a U.S. procedure based sales program (the
"fee-per-use program") and cash available under the Transamerica financing
facility would be sufficient to meet our current operating and capital
requirements through the end of the fiscal year. We now believe that the fee-
per-use program will take longer to implement than originally planned. In an
effort to increase revenues, we believe that it is necessary to:
. Increase consumer awareness of the treatment options
available to BPH patients with the view that an informed
patient and his doctor are more likely to choose the TUNA
procedure;
. Provide opportunities for our field organization to
increase the number of physicians who perform TUNA
Procedures; and
. Implement marketing initiatives to assist physicians build
their practices by increasing the number of TUNA
Procedures performed.
The increased costs associated with this three-pronged approach together with
lower than anticipated revenues from the fee-per-use program will require us to
obtain additional financing to meet our current operating and capital
requirements through the end of the fiscal year. Management is pursuing, and
believes it can obtain, financing to fund operations through the end of this
fiscal year and into fiscal year 2000. Additional financing will likely be
required in order to fund operations throughout fiscal 2000.
We cannot give any assurance that we will be successful in securing any debt or
equity financing, or that such financing, if available, will be on favorable
terms. Any future equity financing would result in dilution to our
stockholders. If we are unable to secure additional financing this year, we
would not be able to continue as a going concern. We would be forced to explore
strategic relationships, reduce staff and discontinue clinical trials, research
and development and marketing and sales activities.
In October 1998, we finalized a commitment for $5.5 million in new debt
financing with Transamerica Technology Finance, a division of Transamerica
Corporation. The facility is secured by our assets and consists of a revolving
accounts receivable-based credit line of up to $3 million and a $2.5 million
equipment term loan. The term loan was funded in full as of December 31, 1998,
at an interest rate of 12% per year. Repayment of that loan is amortized over a
three-year period, with the first monthly payment having been made in December
1998 and continuing monthly thereafter.
As of December 31, 1998, we borrowed approximately $132,000 against the
revolving accounts receivable-based line at a rate of 9.75% per year. We were
eligible to borrow approximately $166,000 against this line on December 31,
1998, and borrowed the remaining available balance of approximately $34,000 in
January 1999.
The revolving credit line has a minimum interest payment of $96,000 per year.
In conjunction with the financing, Transamerica received a 5-year warrant to
purchase 55,000 shares of our common stock at a price of $0.89 per share.
Restructuring Accrual
In September 1997, we announced a restructuring program designed to reduce
costs and improve operating efficiencies by closing our U.K. manufacturing
facility and relocating the manufacturing to our headquarters in Fremont,
California. The charge in 1997 was $2.1 million recorded in Cost of Products
Sold. The remaining accrual balance as of December 31, 1998 is $252,000 and
consists mainly of a grant repayment due over the next twelve months. See also
Footnote 10 to the financial statements.
Risk Factors
In additions to the risks outlined above, our business, results of
operations and financial condition are subject to a number of risk factors,
including the following:
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Risk of Inadequate Funding. We expect our operating losses to continue as we
continue to expend substantial funds for the expansion of sales and marketing
activities, as well as ongoing clinical trials in support of regulatory and
reimbursement approvals and research and development. We may be required to
expend greater than anticipated funds if unforeseen difficulties arise in the
marketing and sales of the TUNA System, and in obtaining necessary regulatory
and reimbursement approvals or in other aspects of our business. Along with
existing cash, cash equivalents, short-term investments and a line of credit
together with cash generated from the future sale of products, we will likely
require additional debt and/or equity financing. Our future liquidity and
capital requirements will depend upon numerous factors, including actions
relating to regulatory and reimbursement matters and the extent to which the
TUNA System gains market acceptance. Any additional financing, if required, may
not be available on satisfactory terms or at all. Debt financing may require us
to pledge assets and to comply with financial and operational covenants. Future
equity financing would result in dilution to the holders of our common stock.
Limited Operating History. We have a limited history of operations. Since our
inception in July 1992, we have been primarily engaged in research and
development of the TUNA System. We have experienced significant operating
losses since inception and, as of December 31, 1998, had an accumulated deficit
of $88.2 million. Unlike companies that have been operating profitably for
years and have a well accepted product, given our limited operating history and
the relative newness of our products, there can be no assurance that we will
ever be successful.
History of Losses and Expectation of Future Losses. Our development and
commercialization of the TUNA System and other new products, if any, will
require substantial product development, clinical, regulatory, marketing and
other expenditures. We expect our operating losses to continue as we continue to
expend substantial resources in expanding marketing and sales activities,
funding clinical trials in support of regulatory and reimbursement approvals and
research and development. There can be no assurance that:
. We will have sufficient funds available to develop our products as we believe
is necessary;
. The TUNA System will be successfully commercialized, or
. We will produce significant revenues from either international or domestic
sales.
As a result, there can be no assurance that we will achieve or sustain
profitability in the future.
Uncertainty of Market Acceptance. The TUNA Procedure represents a new therapy
for BPH, and there can be no assurance that the TUNA System will gain any
significant degree of market acceptance among physicians, patients and health
care payors, even if necessary international and United States reimbursement
approvals are obtained. If the TUNA System does not achieve sufficient market
acceptance, we will not be able to generate revenues necessary to operate our
business, and absent funds available from another source, our business and
operations would be materially and adversely affected. See, "Liquidity and
Capital Resources" and "Risk of Inadequate Funding".
Physicians will not recommend the TUNA Procedure unless they conclude,
based on clinical data and other factors, that it is an attractive alternative
to other methods of BPH treatment, including more established methods such as
TURP and drug therapy. In particular, physicians may elect not to recommend the
TUNA Procedure until such time, if any, as the duration of the relief provided
by the procedure has been established. Broad use of the TUNA System will require
the training of numerous physicians, and the time required to complete such
training could result in a delay or dampening of market acceptance. Even with
the clinical efficacy of the TUNA Procedure established, physicians may elect
not to recommend the procedure unless acceptable reimbursement from health care
payors is available. Health care payor acceptance of the TUNA Procedure will
require evidence of the cost effectiveness of TUNA as compared to other BPH
therapies, which will depend in large part on the duration of the relief
provided by the TUNA Procedure. A thorough analysis of multi-year patient
follow-up data will be necessary to assess the durability of the relief provided
by TUNA therapy. Patient acceptance of the procedure will depend in part on
physician recommendations as well as other factors, including the degree of
invasiveness and rate and severity of complications associated with the
procedure as compared to other therapies.
Uncertainty Relating to Third Party Reimbursement. Our success will be
dependent upon, among other things, our ability to obtain satisfactory
reimbursement from health care payors for the TUNA Procedure. In the United
States and in international markets, third party reimbursement is generally
available for existing therapies used for treatment of BPH. In the United
States, third party reimbursement for the TUNA Procedure will be dependent upon
decisions by the local Medicare Medical Directors to provide coverage for the
TUNA Procedure based on the CPT codes, as well as by individual health
maintenance organizations, private insurers and other payors. Reimbursement
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systems in international markets vary significantly by country. Many
international markets have governmentally managed health care systems that
govern reimbursement for new devices and procedures. In most markets, there are
private insurance systems as well as governmentally managed systems.
Regardless of the type of reimbursement system, we believe that physician
advocacy of the TUNA System will be required to obtain reimbursement.
Availability of reimbursement will depend not only on the clinical efficacy and
direct cost of the TUNA Procedure, but also on the duration of the relief
provided by the procedure. In the United States, TUNA Procedures are currently
being reimbursed by certain private payors. However, due to the age of the
typical BPH patient, Medicare reimbursement is particularly critical for
widespread market acceptance of the TUNA Procedure in the United States. CPT
code number 53852, covering the physician fee component of the TUNA Procedure,
was included in the 1998 edition of CPT codes, which became effective January 1,
1998. If adopted by local Medicare Medical Directors, this code should enhance
the reimbursement process for physicians performing the TUNA Procedure in an
outpatient hospital environment. During 1998, the CPT code was active in less
than half the states. Further, national Medicare reimbursement of TUNA
Procedure costs in an office setting at an adequate level will require
completion by the Health Care Financing Administration ("HCFA") of a review of
the cost and efficacy of the TUNA Procedure. Reimbursement in both the office-
based and ambulatory service centers ("ASC") systems are currently delayed while
Medicare reviews its Y2K compliance issues. Due to this situation, there can be
no assurance that office-based and ASC systems will generate significant revenue
for us in the United States. In addition, there can be no assurance that
reimbursement will be available in international markets, under either
governmental or private reimbursement systems at adequate levels, or that
physicians will support reimbursement for the TUNA Procedure. Furthermore, we
could be adversely affected by changes in reimbursement policies of governmental
or private health care payors. Failure by physicians, hospitals and other users
of our products to obtain sufficient reimbursement from health care payors,
including in particular outpatient hospital Medicare reimbursement in the United
States, or adverse changes in governmental and private third party payors'
policies toward reimbursement for procedures employing our products would have a
material adverse effect on our business, financial condition and results of
operations.
Competition and Technological Advances. Competition in the market for treatment
of BPH comes from invasive therapies, such as TURP, and noninvasive courses of
action, such as drug therapy and watchful waiting. Competition in the market
for minimally invasive devices to treat BPH has increased significantly and is
expected to continue to be intense. Johnson and Johnson's Indigo System
received FDA clearance for United States commercial sales of an interstitial
laser system for BPH treatment in 1997 and Boston Scientific Corporation holds
U.S. and European distribution rights for a microwave system for BPH treatment
manufactured by Urologix. The above mentioned Company's competitors have
significantly greater financial resources than ours which allows them to have
larger technical, research, marketing, sales and distribution programs. There
can be no assurance that our competitors will not succeed in developing or
marketing technologies and products that are more effective or commercially
attractive than any we develop. Such developments could have a material adverse
effect on our business, financial condition and results of operations.
Any product we develop that gains regulatory approval would have to compete
for market acceptance and market share. An important factor in such competition
may be the timing of market introduction of competitive products. Accordingly,
the relative speed with which we can develop products, complete clinical testing
and regulatory approval processes, gain reimbursement acceptance and supply
commercial quantities of the product to the market are expected to be important
competitive factors. We expect that competition in the BPH field will also be
based, among other things, on the ability of the therapy to provide safe,
effective and lasting treatment, cost effectiveness of the therapy, physician,
health care payor and patient acceptance of the procedure, patent position,
marketing and sales capability, and third party reimbursement policies.
Possible Volatility of Stock Price. The stock market has from time to time
experienced significant price and volume fluctuations that are unrelated to the
operating performance of particular companies. The market price of the shares of
our common stock is also likely to be highly volatile. The broad market
fluctuations and the volatility or our stock may adversely affect the market
price of our common stock, and impair our ability to obtain future funding from
the sale of our common or preferred stock.
The following conditions may have a significant effect on the market price of
our common stock:
. Fluctuations in our operating results;
. Announcements of technological innovations or new products;
. FDA and international regulatory actions;
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. Actions with respect to reimbursement matters;
. Developments with respect to patents or proprietary rights;
. Public concern as to the safety of products;
. Changes in health care policy in the United States and internationally;
. Changes in stock market analyst recommendations regarding us, other medical
device companies or the medical device industry generally; and
. General market conditions
U.S. Government Regulation. The FDA under the Federal Food, Drug, and Cosmetic
Act ("FDC Act") regulates our TUNA System in the United States as a medical
device. Pursuant to the FDC Act, the FDA regulates the manufacture,
distribution and production of medical devices in the United States.
Noncompliance with applicable requirements can result in:
. Fines;
. Injunctions;
. Civil penalties;
. Recall or seizure of products;
. Total or partial suspension of production;
. Failure of the government to grant approval for devices; and
. Criminal prosecution.
Medical devices are classified into one of three classes, class I, II or
III, on the basis of the controls necessary to reasonably ensure their safety
and effectiveness. The safety and effectiveness can be assured for class I
devices through general controls (e.g., labeling, pre-market notification and
adherence to GMPs) and for class II devices through the use of special controls
(e.g., performance standards, post-market surveillance, patient registries, and
FDA guidelines). Generally, class III devices are those which must receive pre-
market approval by the FDA to ensure their safety and effectiveness (e.g., life-
sustaining, life-supporting and implantable devices, or new devices which have
not been found substantially equivalent to legally marketed devices).
Before a new device can be introduced into the market, the manufacturer
must generally obtain FDA clearance through either a 510(k) notification or a
pre-market approval ("PMA"). A 510(k) clearance will be granted if the submitted
data establishes that the proposed device is "substantially equivalent" to a
legally marketed class I or II medical device, or to a class III medical device
for which the FDA has not called for a PMA. The FDA may determine that the
proposed device is not substantially equivalent, or that additional data is
needed before a substantial equivalence determination can be made. A "not
substantially equivalent" determination, or a request for additional data, could
delay the market introduction of new products that fall into this category and
could have a materially adverse effect on Our business, financial condition and
results of operations. There can be no assurance that:
. We will obtain 510(k) clearance within the above time frames, if at all, for
any device for which we file a future 510(k) notification; or
. We will not be required to submit a premarket approval application for any
device which we may develop in the future.
. The Fremont facility is currently qualified under FDA good manufacturing
practice regulations and under ISO 9000 standards. In order to maintain these
approvals, we are subject to periodic inspections.
Foreign Government Regulation. Sales of medical devices outside the United
States are subject to regulatory requirements that vary widely from country to
country. The time required to obtain approval for sale in a foreign country may
be longer or shorter than that required for FDA approval and the requirements
may differ. Although we have received regulatory approvals where required for
commercial sale of the TUNA System in all major international markets, the
requirements to receive such approvals could change, or new approvals could be
necessary as we develop new products or modify existing products.
We have received certifications that allow us to affix the CE mark to the TUNA
System, permitting us to commercially market and sell the TUNA System in all
countries of the European Economic Area. Additional product approvals from
foreign regulatory authorities may be required for international sale of our
general electrosurgical device for which a FDA 510(k) notification has been
filed. Failure to comply with applicable
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regulatory requirements can result in loss of previously received approvals and
other sanctions and could have a material adverse effect on our business,
financial condition and results of operations.
Our distributor in Japan, Century Medical, Inc., is responsible for
management of clinical trials and obtaining regulatory and reimbursement
approval for the TUNA System. Such regulatory approval was received from the
Japanese Ministry of Health and Welfare in July 1997 for the previous generation
product, while at the end of fiscal 1998, the new generator and PROVu system
were in the approval process. Failure to obtain timely approval of PROVu and the
new generator or obtain market acceptance for the TUNA Procedure in Japan could
preclude the commercial viability of our products in Japan and could have a
material adverse effect on our business, financial condition and results of
operations.
Limited Manufacturing Experience; Scale-Up Risk. We purchase components used in
the TUNA System from various suppliers and rely on single sources for several
components. We have limited experience in manufacturing our products in
commercial quantities in the United States. Delays associated with any future
component shortages, particularly as we scale up our manufacturing activities in
support of commercial sales, could have a material adverse effect on our
business, financial condition and results of operations because we would not
have products available to sell.
Manufacturers often encounter difficulties in scaling up production of new
products, including problems involving production yields, product recalls,
quality control and assurance, component supply and lack of qualified personnel.
As we have begun to outsource the manufacture of the disposable cartridge and
other components of the TUNA System, such difficulties could arise, resulting in
a material adverse effect on our business, financial condition and results of
operations.
Product Recall Risk. Any products we manufacture or distribute pursuant to FDA
clearances or approvals are subject to pervasive and continuing regulation by
FDA including record keeping requirements and reporting of adverse experience
with the use of the device. Our manufacturing facilities are subject to
periodic inspection by FDA, certain state agencies and foreign regulatory
agencies. We require that our key suppliers comply with international standards
for production of medical devices, and assure through detailed, in-depth audits,
that our suppliers meet both recognized standards and our own stringent quality
standards. Our three key manufacturing subcontractors are ISO9001/EN46001
certified. However, our failure or the failure of our suppliers to comply with
regulatory requirements could have a material adverse effect on our business.
There can be no assurance that we will not be required to incur significant
costs to comply with laws and regulations in the future or that laws or
regulations will not have a material adverse effect upon our business.
Uncertainty Regarding Patents and Protection of Proprietary Technology. Our
success depends in part on the establishment and maintenance of proprietary
technologies. We rely on a combination of patent, copyright and trade secret law
to protect the technology in our products. We hold numerous U.S. and foreign
patents and patent applications relating to our products. The earliest
termination date of any of our United States patents is in 2009, with the
majority of patents scheduled to continue in effect through the year 2013.
There can be no assurance that the steps we take to protect our technology will
be adequate to prevent third parties from misappropriating our technology, or
independently developing similar technology.
In addition to patents, we rely on trade secrets and proprietary know-how,
which we seek to protect, in part, through proprietary information agreements
with employees, consultants and other parties. Our proprietary information
agreements with our employees and consultants contain industry standard
provisions requiring such individuals to assign to us without additional
consideration any inventions conceived or reduced to practice by them while
employed or retained, subject to customary exceptions. There can be no
assurance that proprietary information agreements with employees, consultants
and others will not be breached, that we would have adequate remedies for any
breach, or that our trade secrets will not otherwise become known to or
independently developed by competitors.
Intellectual Property Litigation Risks. The medical device industry has been
characterized by extensive litigation regarding patents and other intellectual
property rights, and companies in the medical device industry have employed
intellectual property litigation to gain a competitive advantage. We are aware
of patents held by other participants in the BPH market, and there can be no
assurance that we will not in the future become subject to patent infringement
claims and litigation or United States Patent and Trademark Office ("USPTO")
interference proceedings. The defense and prosecution of intellectual property
suits, USPTO interference proceedings and related legal and administrative
proceedings are both costly and time consuming. Litigation may be necessary to
18
<PAGE>
enforce our patents, to protect our trade secrets or know-how, or to determine
the enforceability, scope and validity of other's proprietary rights.
Any litigation or interference proceedings could result in substantial
expense and significant diversion of our technical and management personnel. An
adverse determination in litigation or interference proceedings could subject us
to significant liabilities to third parties or require us to seek licenses from
third parties. Although patent and intellectual property disputes in the medical
device area have often been settled through licensing or similar arrangements,
costs associated with such arrangements may be substantial and could include
ongoing royalties. Furthermore, there can be no assurance that necessary
licenses would be available on satisfactory terms or at all. Accordingly, an
adverse determination in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent us from manufacturing and selling our
products, which would have a material adverse effect on our business, financial
condition and results of operations.
Impact of Year 2000. Many currently installed computer systems and software
products are coded to accept, store, or report only two digit year entries in
date code fields. Beginning in the Year 2000 (Y2K), these date code fields will
need to accept four digit entries to distinguish 21/st/ century dates from
20/th/ century dates. The Y2K issue is a result of these programs being written
with two digits instead of four. As a result, computer systems and software used
by companies, including us and our vendors and customers, will need to comply
with the Y2K requirements. We presently believe that as a byproduct of normal
business system modifications and upgrades and the short length of time we have
been in operation, the Y2K issue should not have a material effect on our
current financial position, liquidity or results of operations. However, this
does not completely prevent the possibility of problems arising related to the
Y2K issue that could have a material impact on our operations.
We have been proactive in addressing the Y2K issue internally and
externally. Our primary software system is currently Y2K compliant. We do not
depend on in-house custom systems and generally purchase off-the-shelf software
from reputable vendors who have tested their software for Y2K compliance. The
Y2K issue is being considered for all future software purchases. Although we
believe the Y2K issue will not pose material operational problems for our
computer systems, there can be no assurance that problems arising from the Y2K
issue will be completely eliminated.
We have initiated communication with our significant suppliers and
customers to determine the extent to which our operations are vulnerable to a
failure of any of those third parties to remediate their own Y2K issues. The
Company determined that Medicare coverage for supplies and devices in the
office-based and ASC markets was delayed in mid-1998 due to Medicare announced
Y2K problems. The ASC reimbursement program, which was expected to be effective
January 1, 1999 is not likely to be effective before June 30, 2000. As a result
of the Medicare coverage delays, the Company established a $2.7 million reserve
in the third quarter of 1998 for all office-based and ASC sales. Other than
issues related to Medicare, none of our significant suppliers or large customers
has notified us that they have significant Y2K problems. Even where assurances
are received from third parties, however, there remains a risk that failure of
systems and products of other companies on which we rely could have a material
adverse effect on our business.
Our products are Y2K compliant and are able to operate in the Year 2000 and
beyond. There are two processors used in the TUNA System generator. One
processor does not have date sensitivity while the other does. We have tested
the date sensitive processor and have concluded that it has no significant Y2K
problems.
We believe we have an effective program in place to resolve Y2K issues in a
timely manner. We also have contingency plans for certain critical applications
and are working on such plans for others. These contingency plans involve,
among other actions:
. Manual workarounds (e.g. manual preparation of invoices, paychecks)
---
. Adjusting staffing strategies.
In the event that we do not completely resolve all of the Y2K issues, our
business operations could be adversely affected. Although the resulting costs
and loss of business cannot be reasonably estimated at this time, we have not
and do not expect to have material costs associated with the Y2K issues.
The most reasonably likely worst case scenario relates to our ability to
use our computerized manufacturing and accounting system. Although the software
product is Y2K compliant, other unforeseen factors could render it inoperative,
such as the inability of public utilities to provide service. This occurrence
could
19
<PAGE>
materially adversely effect our business. We could also be required to manually
prepare documents, such as shipping documents, invoices and checks and the like.
Such tasks would be more time consuming and would likely require additional
human resources to complete.
Rights to Founder's Inventions Limited to Urology. The proprietary information
agreement between us and Stuart D. Edwards, one of our founders, obligates Mr.
Edwards to assign to us his inventions and related intellectual property only in
the field of urology. Mr. Edwards has assigned to Rita Medical Systems, Inc.
("RITA") his inventions in the cancer field. Mr. Edwards has conceived of, and
may continue to conceive of, various medical device product concepts for other
fields outside of urology, including certain product concepts for the treatment
of snoring and sleep apnea that have been assigned to an unrelated third party
and certain product concepts in the gynecology field that have been licensed to
another unrelated third party. That party also has an option to purchase all
future technology developed by Mr. Edwards in the gynecology field. Product
concepts outside of urology developed by Mr. Edwards will not be owned by or
commercialized through us, and we will have no rights or ownership interests
with respect thereto.
Risks Relating to RITA. We have entered into a cross license agreement with
RITA, formerly ZoMed International, Inc. Under the cross license, RITA has the
right to use our technology in the cancer field and we have the right to use
RITA technology in the treatment of Urological diseases and disorders. The
cross license between us and RITA allows both companies to develop products for
treatment of prostate cancer and cancers of the lower urinary tract, and we may
therefore become competitors of RITA in this field.
Product Liability Risk; Limited Insurance Coverage. Our business entails the
risk of product liability claims. Although we have not experienced any product
liability claims to date, any such claims could adversely impact our business.
We maintain product liability insurance and evaluate our insurance requirements
on an ongoing basis. There can be no assurance that product liability claims
will not exceed such insurance coverage limits or that such insurance will be
available on commercially reasonable terms or at all.
Item 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
VidaMed, Inc.
We have audited the accompanying consolidated balance sheets of VidaMed, Inc. as
of December 31, 1998 and 1997, and the related consolidated statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1998. Our audits also included the financial
statement schedule listed in the Index at Item 14(a). These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly and in
all material respects, the consolidated financial position of VidaMed, Inc. at
December 31, 1998 and 1997, and the consolidated result of its operations and
its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, present fairly in all
material respects the information set forth therein.
The accompanying financial statements have been prepared assuming that VidaMed,
Inc. will continue as a going concern. As more fully described in Note 13, the
Company has incurred cumulative operating losses from inception through June 30,
1999 of $94.9 million (including a loss of $6.6 million for the six months ended
June 30, 1999),
20
<PAGE>
and expects operating losses to continue into the near future. In addition, the
Company's cash and cash equivalents decreased from $9.4 million at December 31,
1998 to $4.4 million at June 30, 1999. These conditions raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Notes 1 and 13. The financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
/s/ Ernst & Young LLP
Palo Alto, California
January 15, 1999,
except for Note 1, under the caption "Liquidity",
and Note 13, as to which the date is
August 25, 1999
21
<PAGE>
VidaMed, Inc.
Consolidated Balance Sheets
(In thousands except share and per share amounts)
<TABLE>
<CAPTION>
December 31,
1998 1997
-------- --------
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents $ 9,384 $ 8,026
Accounts receivable, net of allowance (1998-$3,540, 1997-$1,059) 228 3,644
Inventory 1,228 1,512
Amount prepaid to contract manufacturer 724 250
Other current assets 455 680
-------- --------
Total current assets 12,019 14,112
Property and equipment, net 1,797 2,647
Other assets, net 316 206
-------- --------
Total assets $ 14,132 $ 16,965
======== ========
Liabilities and stockholders' equity
Current liabilities:
Notes payable, current portion $ 764 $ 480
Accounts payable 338 1,536
Accrued professional fees 317 559
Accrued clinical trial costs 431 372
Accrued and other liabilities 2,362 2,311
Accrued advertising costs 309 309
Accrued interest payable - 422
Restructuring accrual 252 1,000
Current portion of long-term debt and obligations
under capital leases 22 116
Deferred revenue 229 611
-------- --------
Total current liabilities 5,024 7,716
Notes payable and capital leases, long-term portion 1,785 22
Commitments
Stockholders' equity:
Preferred stock, $.001 par value; issuable
in series, 5,000,000 shares authorized; none
outstanding at December 31, 1998 and 1997
Common stock, $.001 par value, 30,000,000 shares
authorized; 19,926,656 and 15,203,401 shares
issued and outstanding at December 31, 1998
and 1997, respectively. 20 15
Additional paid-in-capital 95,727 77,789
Notes receivable from stockholders (205) (205)
Deferred compensation - (26)
Accumulated deficit (88,219) (68,346)
-------- --------
Total stockholders' equity 7,323 9,227
-------- --------
Total liabilities and stockholders' equity $ 14,132 $ 16,965
======== ========
</TABLE>
See accompanying notes.
22
<PAGE>
VidaMed, Inc.
Consolidated Statements of Operations
(In thousands except share and per share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Product sales, net $ 589 $ 9,065 $ 3,510
License fees, grant and other revenue 439 763 314
----------- ----------- -----------
Net revenues 1,028 9,828 3,824
Cost of Products Sold 3,130 7,261 3,679
----------- ----------- -----------
Gross Profit (loss) (2,102) 2,567 145
Operating Expenses:
Research and development 4,241 6,003 5,742
Selling, general and administrative 13,466 13,020 7,890
----------- ----------- -----------
Total operating expenses 17,707 19,023 13,632
----------- ----------- -----------
Loss from operations (19,809) (16,456) (13,487)
Interest and other income 523 345 659
Interest and other expense (587) (359) (715)
----------- ----------- -----------
Net loss $ (19,873) $ (16,470) $ (13,543)
=========== =========== ============
Basic and diluted net loss per share $ (1.10) $ (1.29) $ (1.30)
=========== =========== ============
Shares used in computing basic and diluted
net loss per share 18,133,000 12,786,000 10,382,000
=========== =========== ===========
</TABLE>
See accompanying notes.
23
<PAGE>
VidaMed, Inc.
Statements of Stockholders' Equity
For the Years Ended December 31, 1998, 1997 and 1996
<TABLE>
<CAPTION>
Notes
Additional Common Receivable
Common Paid-In Stock From Deferred
Stock Capital Warrant Stockholders Compensation
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1995 9 45,373 - (85) (219)
Exercise of options to purchase 236,013 - - - - -
shares of common stock - 491 - (120) -
Issuance of 59,716 shares of common stock - - - - -
under the employee stock purchase plan - 355 - - -
Conversion of convertible notes into common stock - - - - -
Common Stock 2 9,676 - - -
Amortization of deferred compensation - - - - 96
Net loss - - - - -
Unrealized investment loss - - - - -
Total comprehensive loss - - - - -
-------------------------------------------------------------
Balances at December 31, 1996 11 55,895 0 (205) (123)
Exercise of options to purchase 96,106 - - - - -
shares of common stock - 251 - - -
Issuance of 4,157,814 shares of common stock, net of -
offering costs of $774,000 4 21,552 - - -
Issuance of 21,039 shares of common stock - - - - -
under the employee stock purchase plan - 91 - - -
Amortization of deferred compensation - - - - 97
Net loss - - - - -
Unrealized investment gain - - - - -
Total comprehensive loss - - - - -
-------------------------------------------------------------
Balances at December 31, 1997 15 77,789 0 (205) (26)
Exercise of options to purchase 36,386 - - - - -
shares of common stock - 83 - - -
Issuance of 53,970 shares of common stock - - - - -
under the employee stock purchase plan - 195 - - -
Issuance of 4,340,004 shares of common stock, net of - - - - -
offering costs of $639,000 5 16,712 - - -
Issuance of 292,895 shares of new common stock - 948 - - -
Amortization of deferred compensation - - - - 26
Net loss - - - - -
Total comprehensive loss - - - - -
------------------------------------------------------------
Balances at December 31, 1998 20 95,727 0 (205) 0
=============================================================
<CAPTION>
Accumulated
Other Total
Accumulated Comprehensive Stockholders'
Deficit Income Equity
------------------------------------------
<S> <C> <C> <C>
Balances at December 31, 1995 (38,333) 10 6,755
Exercise of options to purchase 236,013 - - -
shares of common stock - - 371
Issuance of 59,716 shares of common stock - - -
under the employee stock purchase plan - - 355
Conversion of convertible notes into common stock - - -
Common Stock - - 9,678
Amortization of deferred compensation - - 96
Net loss (13,543) - (13,543)
Unrealized investment loss - (11) (11)
---------
Total comprehensive loss - - (13,554)
------------------------------------------
Balances at December 31, 1996 (51,876) (1) 3,701
Exercise of options to purchase 96,106 - - -
shares of common stock - - 251
Issuance of 4,157,814 shares of common stock, net of
offering costs of $774,000 - - 21,556
Issuance of 21,039 shares of common stock - - -
under the employee stock purchase plan - - 91
Amortization of deferred compensation - - 97
Net loss (16,470) - (16,470)
Unrealized investment gain - 1 1
------------------------------------------
Total comprehensive loss - - (16,469)
----------
Balances at December 31, 1997 (68,346) 0 9,227
Exercise of options to purchase 36,386 - - -
shares of common stock - - 83
Issuance of 53,970 shares of common stock - - -
under the employee stock purchase plan - - 195
Issuance of 4,340,004 shares of common stock, net of - - -
offering costs of $639,000 - - 16,717
Issuance of 292,895 shares of new common stock - - 948
Amortization of deferred compensation - - 26
Net loss (19,873) - (19,873)
---------
Total comprehensive loss - - (19,873)
------------------------------------------
Balances at December 31, 1998 (88,219) 0 7,323
==========================================
</TABLE>
See accompanying notes
24
<PAGE>
VidaMed, Inc.
Consolidated Statements of Cash Flows
(In thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- --- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $(19,873) $(16,470) $(13,543)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 1,489 1,369 1,444
Other - - 26
Changes in assets and liabilities:
Accounts receivable 3,416 (1,231) (2,285)
Inventory 284 (65) (102)
Other current assets 225 (15) (156)
Prepaid contract manufacturer (474) (250) -
Other assets (110) 2 27
Accounts payable (1,198) 290 759
Accrued professional fees (242) 61 161
Accrued clinical trial costs 59 (610) 4
Accrued interest payable (422) 143 150
Accrued advertising costs - (309) -
Accrued restructuring cost (748) 1,000 -
Accrued and other liabilities 51 152 551
Deferred revenue (382) 241 (312)
-------- -------- --------
Net cash used in operating activities (17,925) (15,692) (13,276)
-------- -------- --------
Cash flows from investing activities:
Expenditures for property and equipment (639) (1,757) (693)
Purchases of short-term investments - - (11,788)
Proceeds from maturities of short-term investments - 1,977 17,810
-------- -------- --------
Net cash provided by (used in) investing activities (639) 220 5,329
-------- -------- --------
Cash flows from financing activities:
Principal payments under capital leases (104) (474) (693)
Principal payments of long-term debt (12) (741) (22)
Principal payments of notes payable (2,046) (1,064) (3,650)
Net proceeds from issuance of long-term debt - - 100
Net proceeds from issuance of notes payable
and convertible notes 4,115 - 9,678
Net cash proceeds from issuance of common stock 17,969 21,898 726
-------- -------- --------
Net cash provided by financing activities 19,922 19,619 6,139
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 1,358 4,147 (1,808)
Cash and cash equivalents at the beginning of the period 8,026 3,879 5,687
-------- -------- --------
Cash and cash equivalents at the end of the period $ 9,384 $ 8,026 $ 3,879
======== ======== ========
Supplemental schedule of noncash investing and financing activities:
Issuance of common stock for notes receivable $ - $ - $ 120
-------- -------- --------
Supplemental disclosure of cash flows information:
Cash paid for interest $ 309 $ 654 $ 711
-------- -------- --------
</TABLE>
See accompanying notes.
25
<PAGE>
VIDAMED, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 1998, 1997 and 1996
1. Organization and Summary of Significant Accounting Policies
Organization and Business
VidaMed, Inc. (the "Company" or "VidaMed") was founded as a California
corporation on July 9, 1992 and reincorporated in Delaware in June 1995. The
Company designs, develops, manufactures and markets technologically and
clinically advanced, cost effective devices for urology applications. The
Company's initial focus is the treatment of BPH. The Company commenced
manufacturing production and product sales in 1993. In the United States, the
Company sells its products to urologists, surgery centers and hospitals. Outside
of the United States, the Company sells its products primarily to international
distributors who resell to physicians and hospitals.
Liquidity
As the Company began fiscal 1999, it believed that its current cash balances,
projected cash flows from operations including a U.S. procedure based sales
program (the "fee-per-use program") and cash available under the Transamerica
financing facility would be sufficient to meet its current operating and capital
requirements through the end of the fiscal year. The Company now believes that
the fee-per-use program will take longer to implement than originally planned.
In an effort to increase revenues, the Company believes that it is necessary to:
. Increase consumer awareness of the treatment options
available to BPH patients with the view that an informed
patient and his doctor are more likely to choose the TUNA
procedure;
. Provide opportunities for our field organization to
increase the number of physicians who perform TUNA
Procedures; and
. Implement marketing initiatives to assist physicians build
their practices by increasing the number of TUNA
Procedures performed.
The increased costs associated with this three-pronged approach together with
lower than anticipated revenues from the fee-per-use program will require the
Company to obtain additional financing to meet its current operating and capital
requirements through the end of the fiscal year 1999. Management is pursuing,
and believes it can obtain, financing to fund operations through the end of this
fiscal year and into fiscal year 2000. Additional financing will likely be
required in order to fund operations throughout fiscal 2000.
The Company cannot give any assurance that it will be successful in securing any
debt or equity financing, or that such financing, if available, will be on
favorable terms. Any future equity financing would result in dilution to the
Company's stockholders. If the Company is unable to secure additional financing
this year, it would not be able to continue as a going concern. It would be
forced to explore strategic relationships, reduce staff and discontinue clinical
trials, research and development and marketing and sales activities.
In October 1998, the Company finalized a commitment for $5.5 million in new debt
financing with Transamerica Technology Finance, a division of Transamerica
Corporation. The facility is secured by the Company's assets and consists of a
revolving accounts receivable-based credit line of up to $3 million and a $2.5
million equipment term loan. The term loan was funded in full as of December
31, 1998, at an interest rate of 12% per year. Repayment of that loan is
amortized over a three-year period, with the first monthly payment having been
made in December 1998 and continuing monthly thereafter.
As of December 31, 1998, the Company borrowed approximately $132,000 against the
revolving accounts receivable-based line at a rate of 9.75% per year. The
Company was eligible to borrow approximately $166,000 against this line on
December 31, 1998, and borrowed the remaining available balance of approximately
$34,000 in January 1999.
The revolving credit line has a minimum interest payment of $96,000 per year.
In conjunction with the financing, Transamerica received a 5-year warrant to
purchase 55,000 shares of our common stock at a price of $0.89 per share.
26
<PAGE>
Principles of Consolidation
The consolidated financial statements of the Company include the accounts of
VidaMed and its wholly owned subsidiaries after elimination of inter-company
balances and transactions.
Revenue Recognition
Revenue from product sales is recognized at the time of shipment, net of
allowances for discounts and estimated returns which is also provided for at the
time of shipment. Deferred revenue for warranty contracts are recognized over
the contract period. The Company does not provide price protection or allow a
right of return for products sold.
Revenue derived from the granting of distribution rights is recognized on a
straight-line basis over the term of the distribution agreements. At December
31, 1998, 1997 and 1996, the Company had deferred a total of $229,000, $267,000
and $467,000, respectively, of revenue from the granting of such distribution
rights.
Concentration of Credit Risk
The Company currently sells its products to urologists and hospitals in the
United States and to distributors elsewhere in the Americas, Europe and the
Pacific Rim. The Company performs ongoing credit evaluations of its customers
and generally does not require collateral.
During the third quarter of 1998, the Company recorded a sales reserve of $2.7
million. The $2.7 million reserve was recorded as a reduction in product sales
and an increase in the allowance for doubtful accounts. The affected sales
were recorded primarily during the first and second quarters of 1998 as its
products were sold. At the time the sales were made, Medicare was on record
that it would provide reimbursement for TUNA Procedures performed in office
settings and at ambulatory surgery centers. In August 1998, Medicare announced
that due to its internal year 2000 issues, it would not begin reimbursement for
in-office or ambulatory surgery center treatments before mid-2000, and that
reimbursement would be phased in over a three year period. At the time it first
recorded the sales, the Company reasonably expected to receive payment from its
customers and no future performance obligations of the Company existed. It was
not until the Medicare reimbursement policy changed in August 1998 that the
Company re-evaluated its sales reserve required and that the additional reserve
was recorded.
For the year ended December 31, 1998, Century Medical, Inc. represented 50% of
the Company's net revenues. Century Medical is the Company's exclusive
distributor in Japan. For the years ended December 31, 1997 and 1996, no
customer represented more than 10% of the Company's net revenues.
As of December 1998, the Company had a prepaid materials balance of $724,000
with Telo Electronics, Inc., the manufacturer of the VidaMed Generator. The
Company had $762,000 and $3,557,000 in purchases from Telo Electronics, Inc. in
the years ended December 31, 1998 and 1997, respectively.
Grant Revenue
In July 1993, the Company entered into an agreement with the Department of Trade
and Industry of the United Kingdom, under which the Company's U.K. subsidiary
was entitled to a grant not exceeding (Pounds)750,000 for the establishment of a
facility to develop and manufacture medical devices in Plymouth, England. As
part of the U.K. facility shutdown, the grant is being repaid at a value of
(Pounds)225,000 or approximately $340,000. See also Note 10.
Warranty Costs
The Company provides at the time of sale for the estimated cost of replacing and
repairing products under warranty. The warranty period ranges from 90 days to
one year depending upon the component. Because of the length of the warranty
period, adjustments to the originally recorded provisions may be necessary from
time to time.
27
<PAGE>
Inventories
Inventories are stated at the lower of cost (determined using the first-in,
first-out method) or market value. Inventories consist of the following (in
thousands):
<TABLE>
<CAPTION>
December 31,
------------------
1998 1997
-------- --------
<S> <C> <C>
Raw materials........................................ $ 404 $ 261
Work in process...................................... 261 90
Finished goods....................................... 563 1,161
-------- --------
$ 1,228 $ 1,512
======== ========
</TABLE>
The decrease in inventory balance at December 31, 1998, compared to December 31,
1997, was due primarily to a build up of the old generation VidaMed product in
anticipation of the manufacturing transition from the United Kingdom to the
United States. As a result, the finished goods inventory level was higher at
the end of 1997 than it was at the end of 1998.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided on a
straight-line basis over the estimated useful life of the respective assets,
which range from three to five years. Leasehold improvements are amortized on a
straight-line basis over the shorter of the estimated useful life or the
remaining life of the lease. In accordance with Statement of Financial
Accounting Standard No. 121, Accounting for the Impairment of Long-Lived Assets
to be Disposed of, the Company identifies and records impairment losses, as
circumstances dictate, on long-lived assets used in operations when events and
circumstances indicate that the assets might be impaired and the undiscounted
cash flows estimated to be generated by those assets are less than the carrying
amounts of those assets. No such events have occurred with respect to the
Company's long-lived assets, which consist primarily of machinery, computer
equipment, furniture and leasehold improvements.
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
------------------
1998 1997
-------- --------
<S> <C> <C>
Furniture and fixtures............................... $ 464 $ 457
Machinery and equipment.............................. 3,624 3,445
Computer equipment and software...................... 1,250 901
Leasehold improvements............................... 1,044 972
-------- --------
6,382 5,775
Less accumulated depreciation and
amortization........................................ (4,585) (3,128)
-------- --------
$ 1,797 $ 2,647
======== ========
</TABLE>
Property and equipment includes approximately $22,000 and $1,895,000 recorded
under capital leases at December 31, 1998 and 1997, respectively. Accumulated
amortization relating to leased assets totaled approximately $77,000 and
$1,813,000 at December 31, 1998, and 1997, respectively.
Stock Based Compensation
In October 1995, the Financial Accounting Standards Board issued "Accounting for
Stock-Based Compensation" (Statement 123). Statement 123 is effective for fiscal
years beginning after December 15, 1995. Under Statement 123, stock-based
compensation expense to employees is measured using either the intrinsic-value
method as prescribed by Accounting Principles Board Opinion No. 25 (APB 25),
"Accounting for Stock Issued to Employees," or the fair-value method described
in Statement 123. As allowed by Statement 123, the Company has chosen the
intrinsic-value method as prescribed by APB 25 and will disclose the pro forma
impact of the fair-value method on net income and earnings per share. See Note 7
for additional information on stock based compensation. There is no effect of
adopting the standard on VidaMed's financial position or results of operations.
28
<PAGE>
Foreign Currency Translation
The functional currency for foreign subsidiaries is the United States dollar.
Monetary assets and liabilities denominated in foreign currencies are translated
at the year-end exchange rate. Inventory, property and equipment and non-
monetary assets and liabilities denominated in foreign currencies are translated
at historical rates. Adjustments resulting from these translations are included
in the results of operations and have been immaterial. The Company does not
enter into foreign currency forward exchange contracts.
Reporting Comprehensive Income (Loss)
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No.130, "Reporting Comprehensive Income" (Statement 130). Statement
130 establishes new rules for the reporting and display of comprehensive income
and its components. Statement 130 requires unrealized gains or losses on the
Company's available-for-sale securities and foreign currency translation
adjustments, which prior to adoption were reported in shareholders' equity, to
be included in other comprehensive income (loss). Prior year financial
statements have been reclassified to conform to the requirements of the
Statement 130. There was no impact from the adoption on the Company's financial
position or results of operations.
Net Loss Per Share
Net loss per share is computed using the weighted average number of shares of
common stock outstanding during the periods presented. Securities that could
share in the earnings of the Company are excluded from the computation, as their
effect is anti-dilutive. In February 1997, the Financial Accounting Standards
Board issued Statement No. 128, "Earnings per Share" (Statement 128). Statement
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share exclude any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share are very similar to the
previously named fully diluted earnings per share. All loss per share amounts
have been presented and, where appropriate, restated to conform to the Statement
128 requirement. As the Company incurred loses from operations in each of the
three years in the period ended December 31, 1998, there is no difference
between basic and diluted loss per share amounts for these years.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
Segment Information
Effective January 1, 1998, the Company adopted Statement No. 131, "Disclosure
about Segments of an Enterprise and Related Information" (Statement 131).
Statement 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. Statement 131 also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. The adoption of Statement 131 had no significant effect on results
of operations or the financial position of the Company.
Derivative Instruments and Hedging Activities
In June 1998, the Financial Accounting Standards Board issued Statement No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (Statement 133),
which is required to be adopted for the year ending December 31, 2000.
Management does not anticipate that the adoption of Statement 133 will have a
significant effect on results of operations or the financial position of the
Company.
2. Fair Market Value of Financial Instruments
The Company considers all highly liquid investments with maturities of 90 days
or less from the date of purchase to be cash equivalents. The Company invests
its excess cash in deposits with banks. Short-term investments consist of
29
<PAGE>
commercial paper and government securities with remaining maturities at the date
of purchase of greater than 90 days and less than one year.
The Company accounts for marketable investments under Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities," (Statement 115). Under Statement 115, management determines
the appropriate classification of debt securities at the time of purchase and
re-evaluates such designation as of each balance sheet date. To date, all
marketable securities have been classified as available-for-sale and are carried
at fair value at quoted market prices. Unrealized gains and losses are reported
as a separate component of accumulated comprehensive income. The amortized cost
of debt securities in this category is adjusted for amortization of premiums and
accretion of discounts to maturity. Such amortization or accretion is included
in interest income or interest expense respectively. The cost of securities
sold is based on the specific identification method. Interest earned on
securities classified as available-for-sale is included in interest income.
By policy, the Company limits similar types of investments and diversifies
investing activities utilizing several investment agencies.
As of December 31, 1998 and 1997, the Company had U. S. government securities
and commercial paper available for sale at a fair market value of approximately
$8,383,000 and $7,273,000, respectively, with no gross unrealized gains or
losses. As of December 31, 1998 and 1997, all available-for-sale securities are
recorded as cash equivalents as the maturities of the investments at the date of
purchase are less than 90 days. For the years ended December 31, 1998, 1997 and
1996, gross realized gains and losses on sales were immaterial.
The fair market value of the long-term debt approximates its carrying value
based on an assessment of maturity, the variable interest rates and the
incremental borrowing rate for similar debt.
3. Related Party Transactions
The Company has cross licensed technology with RITA Medical Systems (RITA),
formerly known as ZoMed International, Inc., a privately-held development stage
company founded by certain of the Company's founders and initially financed by
certain of the Company's current investors. The cross license grants RITA the
exclusive right to use VidaMed technology in the cancer field and grants the
Company the right to use RITA technology in the treatments of Urological
disorders other than cancer, and allows both companies to participate in the
field of prostate and lower urinary tract cancer treatment. As consideration
for the cross license, RITA issued the Company 1.8 million shares of RITA common
stock which represented a 10% ownership in RITA immediately following its
private placement. The current percentage of ownership has dropped well below
the original 10% to approximately 1.9%. The Company estimates the value of such
securities to be less than $10,000. This investment is carried at the
historical cost basis of the technology of $0. RITA will also pay royalties to
the Company based on a percentage of net sales of products incorporating VidaMed
technology, subject to an aggregate maximum of $500,000.
4. Long Term Debt and Notes Payable
In April 1995, the Company obtained a $3,000,000 secured credit facility and
subsequently borrowed and paid-off the full amount. In connection with this
agreement, the Company issued the lender a warrant to purchase 72,000 shares of
common stock at $4.55 per share.
In January 1998, the Company entered into a financing agreement with Silicon
Valley Bank, for a $1,500,000 42-month term loan. As of December 31, 1998, this
loan has been paid in full.
Also during 1998, the Company finalized a commitment for $5.5 million in new
debt financing with Transamerica Technology Finance, a division of Transamerica
Corporation. The facility is secured by the Company's assets and consists of a
revolving accounts receivable-based credit line of up to $3 million and a $2.5
million equipment term loan. As of December 31, 1998, the term loan had funded
in full at a rate of 12% and replaced the open balance of the $1.5 million 42-
month term loan with Silicon Valley Bank. Repayment of that loan is amortized
over a three-year period, with the first monthly payment having been made in
December 1998 and continuing monthly thereafter. As of December 31, 1998, we
borrowed approximately $132,000 against the revolving accounts receivable-based
line at a rate of 9.75% per year. We were eligible to borrow approximately
$166,000 against this line on December 31, 1998, and borrowed the remaining
available balance of approximately $34,000 in January 1999. The revolving credit
line has a minimum interest payment of $96,000 per year. In conjunction with
the
30
<PAGE>
financing, Transamerica received a 5-year warrant to purchase 55,000 shares of
VidaMed common stock at a price of $0.89 per share.
All future principal payments for long-term debt and notes payable at December
31, 1998 is a combination of $660,000, $744,000 and $1,041,000 due in the years
ending December 31, 1999, 2000 and 2001, respectively.
5. Capital and Operating Leases
In 1993 and 1994, the Company entered into master lease lines of credit to
finance up to $3,000,000 of equipment purchases. The Company had borrowed
$2,165,000 from these lines and as of December 31, 1998, $22,000 remains unpaid
from these lines.
In June 1994, the Company entered into an additional master lease line of credit
to finance up to $1,900,000 of equipment purchases. The availability of this
lease line expired July 1, 1995 at which time the Company had utilized
$1,065,000 under this lease line of credit. Under the lease line of credit
agreements, the Company issued warrants to purchase an aggregate of 47,000
shares of common stock at exercise prices ranging from $3.00 to $12.83 per
share. The warrants expire in 2002 and 2004. As of December 31, 1998, no
shares had been purchased under the terms of the warrants.
The Company moved in July 1997 to a 35,000 square foot facility in Fremont,
California. The Company leases its office and research facilities under
operating lease agreements. Future minimum lease payments at December 31, 1998
under capital leases and future obligations under noncancellable operating
leases are as follows (in thousands):
<TABLE>
<CAPTION>
Operating Capital
Leases Leases
--------- -------
<S> <C> <C>
1999...................................... $ 408 $ 23
2000...................................... 421 -
2001...................................... 433 -
2002...................................... 183 -
------ -------
Total minimum payments required........... $1,445 23
======
Less amount representing interest......... (1)
-------
Present value of minimum lease payment.... 22
Less amount due within one year........... (22)
-------
Amount due after one year................. $ -
=======
</TABLE>
Rent expense for the years ended December 31, 1998, 1997 and 1996 was $537,000,
$433,000 and $346,000, respectively.
6. Convertible Subordinated Notes Payable
In March 1996, the Company completed the sale of $10.1 million in 5% convertible
subordinated notes (the Notes). The Notes were convertible into common stock of
VidaMed based upon a percentage (ranging from 80% to 85%) of the average closing
bid price over a period of five trading days prior to conversion. As of December
31, 1996 all of the $10.1 million in principal and accrued interest on the Notes
had been converted into an aggregate of 1,375,676 shares of common stock.
7. Stockholders' Equity
Common Stock
In February 1997, the Company entered into an equity financing agreement with a
European investment bank which provided the Company with the option to sell to
such investment bank up to $10,000,000 of VidaMed common stock in increments of
up to $2,500,000. Under this arrangement, the common stock was priced at a 10%
discount to the current market price at the time of sale, subject to adjustment.
As of December 31, 1997 the Company had issued 1,570,000 shares of common stock
under the arrangement, resulting in approximately $10,000,000 of proceeds.
Under this arrangement, the Company issued to the investment bank warrants to
purchase common stock, which after being adjusted according to their terms as a
result of subsequent financing transactions, resulted in the
31
<PAGE>
issuance of a total of 186,000 warrants. These warrants range in exercise price
from $5.95 to $9.30. Each warrant has a term of three years from the original
dates of issuance in 1997.
In September 1997, the Company completed a private placement with certain
investors. In this transaction, the Company issued 2,600,000 shares of common
stock at a purchase price of $4.75 per share resulting in net proceeds of
$11,700,000 to the Company. In connection with this financing, the Company
issued warrants to purchase an aggregate of 629,000 shares of common stock at an
exercise price of $4.00 per share.
In May 1998, the Company completed a sale of publicly registered common stock
with certain investors, officers and directors. In this transaction, the
Company issued 4,340,004 shares of common stock at a purchase price of $4.00 per
share resulting in net proceeds of $16,717,000 to the Company. In connection
with this financing, the Company issued to the investors 3-year warrants to
purchase an aggregate of 1,085,000 shares of common stock at an exercise price
of $5.00 per share for no additional consideration.
As of December 31, 1998, the Company has reserved a total of 2,074,000 shares of
common stock for issuance upon the conversion of outstanding warrants.
Notes Receivable from Stockholders
Interest on notes receivable from stockholders accrues at rates ranging from
6.73% to 7.96% per annum. Principal and interest payments are due at various
times after December 1999.
Stock Options
The Company has elected to follow APB 25 and related Interpretations in
accounting for its employee stock options and employee stock purchase plan
because, as discussed below, the alternative fair value accounting provided for
under Statement No. 123 requires use of option valuation models that were not
developed for use in valuing employee stock options. Under APB 25, because the
exercise price of the Company's employee stock options equals the market price
of the underlying stock on the date of grant, no compensation expense is
recognized.
In July 1992, the board of directors adopted the 1992 Stock Plan (the "Plan").
As amended during 1998, the Company has reserved 4,300,000 shares of common
stock for issuance upon exercise of options granted under the Plan.
In the year ended December 31, 1997 the Board of Directors voted on and approved
two stock option repricings. The Company repriced options as an incentive plan
in order to retain key employees. All employees were offered the repriced value
for options in exchange for a six to twelve month lock up of option exercising
rights. The first repricing occurred in May 1997 and revalued the option price
at $6.875 for all current employees excluding outside board members. The
Company did not record any compensation expense under APB 25 resulting from this
repricing as the exercise price of $6.875 per share equaled the fair market
value of the common stock at the date of the Board of Directors vote, and the
fair market value of the Company's common stock further declined from the time
the repricing was approved to the time employees agreed to the new terms of the
repriced options. The second repricing occurred in September 1997 and revalued
the option price at $4.813 for all current employees excluding outside board
members. The Company did not record any compensation expense under APB 25
resulting from this repricing as the exercise price of $4.813 per share equaled
the fair market value of the common stock at the date of the Board of Directors
vote, and compensation which resulted from an increase in the fair market value
of the Company's common stock from the time the repricing was approved to the
time employees agreed to the new terms of the repriced options was immaterial.
The Plan provides for both incentive and nonqualified stock options to be
granted to employees and consultants. The Plan provides that incentive stock
options will be granted at no less than the fair value of the Company's common
stock (no less than 85% of the fair value for nonqualified stock options) as
determined by the board of directors at the date of the grant. If, at the time
the Company grants an option, the optionee owns more than 10% of the total
combined voting power of all the classes of stock of the Company, the option
price shall be at least 110% of the fair value and the option shall not be
exercisable for more than five years after the date of grant. The options
become exercisable over periods determined by the board of directors, which is
currently four years. Except as noted above, options expire no more than ten
years after the date of grant, or earlier if employment terminates.
32
<PAGE>
In April 1995, the stockholders approved the 1995 Director Option Plan (Director
Plan). A total of 200,000 shares of common stock have been authorized for
issuance. Each non-employee director automatically is granted a non-statutory
option to purchase 13,334 shares of common stock upon election to the board, and
annual non-statutory option for 3,334 shares of common stock.
Activity under the Plans is summarized below:
<TABLE>
<CAPTION>
Shares Weighted Avg.
Available Options Outstanding Fair Value Number of
--------------------------------
for Grant Number of Weighted-Avg. Grant Options
of Options Shares Exercise Price Date Exercisable
- --------------------------------------------------- ---------- ------------- ----- -----------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995 334,924 1,065,228 $ 3.54 299,651
Shares authorized 1,000,000 -- --
Options granted (855,281) 855,281 $ 9.71 $ 7.14
Options exercised -- (236,013) $ 1.91
Options canceled 217,949 (217,949) $ 6.66
---------- ----------
Balance at December 31, 1996 697,592 1,466,547 $ 7.02 376,570
Shares authorized 366,666 -- --
Options granted (1,674,883) 1,674,883 $ 5.08 $ 3.93
Options exercised -- (94,994) $ 2.61
Options canceled 1,165,276 (1,165,276) $ 8.78
---------- ----------
Balance at December 31, 1997 554,651 1,881,160 $ 4.42 328,535
Shares authorized 1,200,000
Options granted (1,957,830) 1,957,830 $ 2.69 $ 4.17
Options exercised -- (36,386) $ 2.29
Options canceled 277,723 (277,723) $ 4.57
---------- ----------
Balance at December 31, 1998 74,544 3,524,881 $ 3.50 944,785
========== ==========
</TABLE>
Exercise prices for options outstanding as of December 31, 1998 ranged from
$0.188 to $13.125 based on the following price ranges. The weighted-average
remaining contractual life of those options is 8.53 years.
<TABLE>
<CAPTION>
Number Weighted Average Number
Range of Outstanding Weighted Average Contractual Exercisable Weighted Average
Exercise Prices as of 12/31/98 Exercise Price Life as of 12/31/98 Exercise Price
=============== ============== ================ ====== ============== ================
<S> <C> <C> <C> <C> <C> <C>
$ 0.188 - $ 0.60 30,751 $0.44 4.24 30,751 $ 0.44
$ 0.781 - $ 0.781 734,370 $0.78 9.77 9,581 $ 0.78
$ 1.283 - $ 3.69 1,032,582 $3.37 8.41 250,943 $ 2.64
$ 3.75 - $ 4.63 818,089 $4.45 8.79 73,263 $ 4.09
$ 4.81 - $13.125 909,089 $5.10 7.51 580,247 $ 5.10
</TABLE>
In April 1995, the stockholders approved the 1995 Employee Stock Purchase Plan
(Purchase Plan). As amended in 1998, a total of 400,000 shares of common stock
have been authorized for issuance. 140,795 shares have been issued under the
Purchase Plan as of December 31, 1998. Under the Purchase Plan participating
employees may contribute up to 15% of their salary to purchase shares of the
Company's common stock. The purchase price is equal to 85% of the fair market
value of the common stock based on the lower of the first day of the offering
period or last day of the purchase period.
Pro forma information regarding net loss and loss per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options granted subsequent to December 31, 1994 under the fair
value method of that Statement. The fair value for these options was estimated
at the date of grant using a Black-Scholes option pricing model with the
following weighted-average assumptions for 1998, 1997 and 1996, respectively:
risk-free interest rates of 4.74%, 6.00% and 5.88%; dividend yields of 0.0%;
volatility factors of the expected market price of the Company's common stock of
1.0, 0.897 and 0.924; and a weighted-average expected life of the option of 3.0
years.
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input
33
<PAGE>
of highly subjective assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands except for loss per share amounts):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Pro forma net loss ($22,223) ($19,950) ($14,785)
======== ======== ========
Pro forma loss per share ($1.23) ($1.56) ($1.42)
======== ======== ========
</TABLE>
Statement 123 is applicable only to options granted subsequent to December 31,
1994 and its proforma effect will not be fully reflected until 1999.
The Company recorded deferred compensation for the difference between the grant
price and the deemed fair value of the Company's common stock, as determined by
the board of directors, for certain options granted in the twelve-month period
prior to the Company's initial public offering. This deferred compensation
totaled $436,000, and was amortized over the vesting period of the options
through 1998. Amortization of deferred compensation of $26,000, $97,000 and
$96,000 was recorded in the years ended December 31, 1998, 1997 and 1996,
respectively.
Warrants
Warrants issued in connection with equity and debt arrangements are valued using
the Black-Scholes option valuation model. Warrants issued to underwriters and
similar parties in connection with equity financings are accounted for as stock
issuance costs with an equal amount recorded as additional paid-in capital.
Warrants issued to purchasers of the Company's equity securities are not
specifically accounted for as their value is a sub-component of additional paid-
in capital. The fair value of warrants issued in connection with debt
arrangements, if material, is accounted for as a debt discount and amortized as
additional interest expense over the term of the related debt.
8. Income Taxes
The Company accounts for income taxes under Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes."
As of December 31, 1998, the Company had Federal and California net operating
loss carry forwards of approximately $52,300,000 and $18,100,000, respectively.
Additionally, the Company had foreign net operating loss carry forwards of
approximately $19,300,000. The Federal net operating loss carry forwards will
expire at various dates beginning in 2007 through 2012 if not utilized. The
California net operating losses will expire at various dates beginning in 1999
through 2002 if not utilized.
Utilization of the net operating losses may be subject to an annual limitation
due to the ownership change rules provided by the Internal Revenue Code of 1986
and similar state provisions. The annual limitation may result in the
expiration of the net operating losses before utilization.
Significant components of the Company's deferred tax assets (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------------------
1998 1997
---------- ----------
<S> <C> <C>
Deferred tax assets:
U.S. Net operating loss carry forwards $ 20,100 $ 16,700
Foreign net operating losses 6,400 5,300
Research credit (expires in 2007 through 2012) 1,000 900
Deferred revenue - 200
Capitalized research and development for California purposes 1,300 1,200
Other 2,300 400
---------- ----------
Total deferred tax assets 31,100 24,700
Valuation allowance for deferred tax assets (31,100) (24,700)
---------- ----------
</TABLE>
34
<PAGE>
<TABLE>
<S> <C> <C>
Net deferred tax assets $ - $ -
========== ==========
</TABLE>
During the years ended December 31, 1997 and 1996, the valuation allowance for
deferred tax assets increased by $6,200,000 and $5,000,000, respectively, due to
the Company's continuing operating losses.
9. Geographic Segment Data
The Company's business activities include the design, development, manufacture
and marketing of devices for urology applications and have been organized into
one operating segment. The Company's domestic operations primarily consist of
product development, sales and marketing. The Company's foreign operations
consist of subsidiaries in the United Kingdom and Australia. The Company's
subsidiary in the U.K. was established in 1993 and was engaged in product
development, manufacturing, sales and marketing and product distribution
worldwide. The shutdown of the U. K. facility in November 1997 has left the U.K.
with operations related only to sales and clinical studies. The Australian
subsidiary was established in 1994 and operates as a sales and marketing office
for the Asia Pacific region. Inter-company sales are based on the company's
current standard cost.
Information regarding geographic areas is as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
Revenue* Long lived Revenue* Long lived Revenue* Long lived
assets assets assets
<S> <C> <C> <C> <C> <C> <C>
U.S. $ (119) $1,774 $7,889 $2,619 $2,740 $1,168
Europe $ 304 $ 7 $1,033 $ 1 $ 853 $1,052
Asia $ 843 $ 16 $ 906 $ 27 $ 232 $ 39
------ ------ ------ ------ ------ ------
Total $1,028 $1,797 $9,828 $2,647 $3,825 $2,259
------ ------ ------ ------ ------ ------
</TABLE>
*Revenue is attributed to geographic areas based on the location of the
customers.
10. Restructuring Accrual
In September 1997, VidaMed announced a restructuring program designed to reduce
costs and improve operating efficiencies by closing the company's U.K.
manufacturing facility. The charge in 1997 was $2.1 million recorded in Cost of
Products Sold.
The elements of the total charge as of December 31, 1998 are as follows (in
thousands):
<TABLE>
<CAPTION>
Representing
---------------------------------------
Cash Outlays
------------------
Total Asset
Charges Write-down Completed Future
<S> <C> <C> <C> <C>
Fixed assets $ 390 $ 390 $ - $ -
Facility shut down 1,305 - 1,305 -
Grant Repayment 405 - 153 252
------ ------- ------- ------
Total Special Charges $2,100 $ 390 $ 1,458 $ 252
------ ------- ------- ------
</TABLE>
11. Commitments
In January 1999, the Company signed a manufacturing agreement with Zeiss
Humphrey Systems, a local medical device manufacturer, to produce the VidaMed
PROVu disposable cartridge. The three-year contract runs through the year 2001
and calls for the Company to purchase a minimum of 10,000 units over the three-
year period. If VidaMed terminates this agreement prior to expiration or fails
to make the minimum purchases thereunder, the Company would have to pay at least
$200,000, but no more than $750,000 to the manufacturer.
In October 1998, the Company entered into retention agreements with certain
executive officers. Under those agreements, the Company was obligated to pay up
to $810,000 on April 1,1999, if those officers
35
<PAGE>
remained with the Company through April 1, 1999. If any of these officers left
the Company prior to April 1, 1999, they would not receive a retention payment.
36
<PAGE>
12. Subsequent Events
In February 1999, VidaMed announced a plan to outsource the manufacturing of the
PROVu disposable cartridge hand piece to Zeiss Humphrey Systems, a Silicon
Valley manufacturer. Due to the elimination of the manufacturing function, the
Company terminated employment with 18 people or 21% of its workforce from the
operations and administration departments.
13. Going Concern
The accompanying financial statements have been prepared assuming that VidaMed,
Inc. will continue as a going concern. The Company has incurred cumulative
operating losses from inception through June 30, 1999 of $94.9 million
(including a loss of $6.6 million for the six months ended June 30, 1999). The
Company also expects operating losses to continue into the near future as it
expends substantial funds for the expansion of sales and marketing activities,
as well as ongoing clinical trials in support of regulatory and reimbursement
approvals and research and development. In addition, the Company's cash and cash
equivalents decreased from $9.4 million at December 31, 1998 to $4.4 million at
June 30, 1999. These conditions raise substantial doubt about the Company's
ability to continue as a going concern. The Company is actively pursuing
various options which include securing additional equity financing and believes
that sufficient funding will be available to achieve its planned business
objectives. See also Note 1 in regard to these matters. The financial
statements do not include any adjustments to reflect the possible future effects
on the recoverability and classification of assets or the amounts and
classification of liabilities that may result from the outcome of this
uncertainty.
PART III
Item 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item relating to directors is incorporated
by reference to the information under the caption "Proposal No. 1 - Election of
Directors" in the Company's definitive proxy statement for its 1999 Annual
Meeting of Stockholders (the "Proxy Statement") to be filed with the Commission
within 120 days after the end of the Company's fiscal year as allowed by general
instruction G(3) to form 10-K.
The executive officers of the Registrant, who are appointed by the board of
directors, and their ages and positions with the Company as of March 15, 1999
are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
David J. Illingworth 45 Chairman, President and Chief Executive Officer
Richard D. Brounstein 49 Vice President, Finance and Chief Financial Officer
Randy D. Lindholm 43 Executive Vice President, Worldwide Sales and Marketing
Robin L. Bush 41 Vice President, Regulatory Affairs and Clinical Affairs
John N. Hendrick 47 Vice President and Chief Operating Officer
</TABLE>
David J. Illingworth became Chairman of the Board, President and Chief
Executive Officer on April 6, 1998. He has served as a director of the Company
since February 1998. From January 1993 through March 1998, Mr. Illingworth held
various positions with Nellcor Puritan Bennett, Inc., a wholly owned subsidiary
of Mallinckrodt Inc., most recently serving as Executive Vice President and
President, Alternative Care Business. Prior to joining Nellcor, Mr. Illingworth
spent 15 years with General Electric in their medical systems business. Mr.
Illingworth serves as a Director of Somnus Medical Technologies, Inc. He holds a
B.S. in Engineering from Texas A & M University. Effective August 1, 1999, Mr.
Lindholm replaced Mr. Illingworth as President and Chief Executive Officer, and
Mr. Illingworth assumed the newly created role of Executive Chairman.
Richard D. Brounstein has served as Vice President of Finance and Chief
Financial Officer since May 1997. From 1989 to 1997 he served as Vice President
Finance and Administration and Chief Financial Officer for MedaSonics, Inc., a
manufacturer of ultrasound medical equipment. Mr. Brounstein holds a B.S. in
Accounting and a MBA in Finance from Michigan State University. He is a
Certified Public Accountant.
37
<PAGE>
Randy D. Lindholm has served as Executive Vice President of World Sales and
Marketing since July 1998. From 1993 to 1998 he served as Vice President of
Americas Field Operations of Nellcor Puritan Bennett, a wholly owned subsidiary
of Mallinckrodt Inc., a manufacturer of medical devices. Prior to joining
Nellcor, Mr. Lindholm spent 16 years with General Electric in their medical
systems business. Mr. Lindholm holds a B.S. in Electrical Engineering from
Michigan Tech University. Effective August 1, 1999, Mr. Lindholm replaced
Mr. Illingworth as President and Chief Executive Officer, and Mr. Illingworth
assumed the newly created role of Executive Chairman.
Robin L. Bush has served as Vice President of Regulatory Affairs and
Clinical Affairs since July 1997. From 1988 to 1997 Ms. Bush was Director of
Regulatory Affairs and Quality Assurance for Aesculap, Inc., a manufacturer of
surgical instruments. Ms. Bush has 20 years experience with medical device
companies, managing regulatory affairs, quality assurance, clinical trials and
compliance functions. Ms. Bush is a certified Regulatory Affairs Professional
(RAC). Ms. Bush holds a B.A. in Human Biology and Psychology from Stanford
University and an MBA from Golden Gate University.
John N. Hendrick joined the Company in September 1994 as Vice President and
Chief Operating Officer. From 1988 until joining VidaMed, Mr. Hendrick was Vice
President of Operations for Allergan Medical Optics, a division of Allergan,
Inc. which manufactures ophthalmic and refractive surgical products. Mr.
Hendrick holds a B.A. in Business Administration from the University of San
Bernadino.
PART IV
Item 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
1. Financial Statements
Included in Part II, Item 8 of this Report:
<TABLE>
<S> <C>
Independent Auditors' Report 22
Consolidated Balance Sheets as of December 31, 1998 and 1997 23
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997 and 1996 24
Consolidated Statement of Stockholders' Equity (Net Capital
Deficiency) for the years ended December 31, 1998, 1997 and 1996 25
</TABLE>
38
<PAGE>
<TABLE>
<S> <C>
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996 26
Notes to Consolidated Financial Statements 27
</TABLE>
2. Financial Statement Schedules
Schedule II is included, on page 46. All other schedules are omitted because
they are not applicable, or not required, or because the required information is
included in the consolidated financial statements or notes thereto.
3. Exhibits
Exhibit No. Description
---------- ------------------------------------------------------------
3.1 (1) Restated Certificate of Incorporation of the Company filed
with the Delaware Secretary of State on June 28, 1995.
3.2 (2) Certificate of Designation of Rights, preferences and
Privileges of Series A Participating Preferred Stock of the
Company filed with the Delaware Secretary of State on
January 13, 1997.
3.3 (1) Restated Bylaws of the Company
4.1 (1) Form of common Stock Certificate of the Company.
4.2 (1) Warrant to Purchase Shares of Series B Preferred Stock,
dated April 13, 1993, issued to Dominion Ventures, Inc.
4.3 (1) Warrant Purchase Agreement, dated November 8, 1993, between
the Company and Dominion Ventures, Inc. and Warrant to
Purchase Shares of Series C Preferred Stock, issued to
Dominion Ventures, Inc.
4.4 (1) Warrant Purchase Agreement, dated June 30, 1994, between the
Company and LINC Capital Management Services, Ltd. and
Warrant to Purchase Shares of Series D Preferred Stock,
dated June 30, 1994, issued to LINC Capital Management
Services, Ltd.
4.5 (1) Representative Form of Note Subscription Agreement and
Convertible Subordinated Promissory Note.
4.6 (2) Preferred Shares Rights Agreement dated as of January 27,
1997, between the Company and American Securities Transfer &
Trust, Inc. including the Certificate of Designations, the
Form of Rights Certificate and the Summary of Rights
attached thereto as Exhibit A, Exhibit B and Exhibit C,
respectively.
4.7 (3) Investment agreement, dated as of February 4, 1997, between
the Company and MeesPierson Clearing Services B.V.,
including Form of Pricing Period Confirmation, Form of
Warrant and Form of Opinion attached thereto as Exhibit A,
Exhibit B and Exhibit C, respectively.
4.8 (4) Purchase Agreement, dated as of September 22, 1997, among
the Company and certain purchasers named therein, including
Schedule of Investors, Form of Common Stock Purchase Warrant
and Form of Opinion attached thereto as Exhibit A, Exhibit B
and Exhibit C, respectively.
10.1 (1) Form of Indemnification Agreement between the Company and
each of its directors and officers.
39
<PAGE>
10.2 (2) 1992 Stock Plan, as amended.
10.3 (5) 1995 Director Option Plan, as amended.
10.4 (1) 1995 Employee Stock Purchase Plan.
10.5 (1) Dominion Ventures Master Lease Agreement, dated April 13,
1993, between the Company and Dominion Ventures, Inc., and
First Amendment thereto.
10.6 (1) Master Lease Agreement, dated June 24, 1994, between the
Company and LINC Capital Management Services, Inc.
10.7 (1) Representative Form of International Distribution Agreement.
10.8 (1) Cross License Agreement, dated August 2, 1994, between the
Company and RITA, formerly ZoMed International, Inc.
10.9 (1) International Distribution Agreement, dated May 9, 1994,
between the Company and Century Medical, Inc.
10.10 (1) Grant Agreement, dated July 19, 1993, between the Company
and the United Kingdom Department of Trade and Industry.
10.11 (1) Letter employment agreement, dated August 26, 1994, between
the Company and John N. Hendrick.
10.12 (1) Letter employment agreement, dated August 31, 1994, between
the Company and James A. Heisch.
10.13 (1) Restated Shareholder Rights Agreement, dated November 23,
1994, among the Company and holders of the Company's
Registerable Securities
10.14 (1) Loan and Security Agreement dated April 20, 1995 between the
Company and Venture Lending and Leasing, Inc. and related
letter agreement.
10.15 (6) Operating Lease dated April 3, 1997, between the Company and
Hopkins Brothers.
10.16 (6) Loan and Security Agreement, dated January 13, 1998, between
the Company and Silicon Valley Bank.
10.17 (8) Loan and Security Agreement, dated October 20, 1998, between
the Company and Transamerica Business Credit Corporation.
10.18 (8) Manufacturing Agreement, dated January 5, 1999, between the
Company and Humphrey Systems
21.1 (1) Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors (see page
42 of this report).
24.1 (7) Power of Attorney.
27.1 Financial Data Schedule.
___________________
(1) Filed as an Exhibit to the Company's Registration Statement on Form S-1
(File No. 33-90746) and incorporated herein by reference.
40
<PAGE>
(2) Filed as an Exhibit to the Company's Registration Statement on Form 8-A
filed with the Securities and Exchange Commission on January 31, 1997 and
incorporated herein by reference thereto.
(3) Filed as an Exhibit to the Company's Current Report on form 8-K filed with
the Securities and Exchange Commission on March 14, 1997 and incorporated
herein by reference thereto.
(4) Filed as an Exhibit to the Company's Current Report on Form 8-K filed with
the Securities and Exchange Commission on September 24, 1997 and
incorporated herein by reference thereto.
(5) Filed as an Exhibit to the Company's Registration Statement on Form S-8
(File No. 33-80619) and incorporated herein by reference.
(6) Filed as an Exhibit to the Company's Report on Form 10-K for the fiscal
year ended December 31, 1997, and incorporated herein by reference.
(7) Included on the signature page of the original Report on Form 10-K for the
fiscal year ended December 31, 1998, and incorporated herein by reference.
(8) Filed as an Exhibit to the Company's original Report on Form 10-K for the
fiscal year ended December 31, 1998.
b) Reports on Form 8-K
The Company was not required to and did not file any reports on Form
8-K during the three months ended December 31, 1998.
SIGNATURES
As set forth by the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Fremont, State of California, on the 14th day of December, 1999.
VIDAMED, INC.
By /s/ John F. Howe
------------------------
John F. Howe,
Chief Financial
Officer
41
<PAGE>
Schedule II - Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Allowance for Doubtful Accounts (in thousands)
Charged to Charged to Balance at
Balance at Beginning costs and Other End of
Description of Period Expenses Accounts Deductions Period
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance 12/31/96 43 125 0 0 168
Balance 12/31/97 168 891 0 0 1,059
Balance 12/31/98 1,059 3,359* 0 (878) 3,540
</TABLE>
* The $3.4 million increase in the allowance account for 1998 includes the $2.7
million sales reserve discussed in Note 1 of the financial statements under the
caption "Concentration of Credit Risk."
42
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<PERIOD-START> JAN-01-1998 JAN-01-1997 JAN-01-1996
<PERIOD-END> DEC-31-1998 DEC-31-1997 DEC-31-1996
<CASH> 9,384 8,026 3,879
<SECURITIES> 0 0 1,976
<RECEIVABLES> 3,768 4,703 2,581
<ALLOWANCES> 3,540 1,059 168
<INVENTORY> 1,228 1,512 1,447
<CURRENT-ASSETS> 12,019 14,112 10,380
<PP&E> 6,382 5,775 5,045
<DEPRECIATION> 4,585 3,128 2,786
<TOTAL-ASSETS> 14,132 16,985 12,847
<CURRENT-LIABILITIES> 5,024 7,716 7,841
<BONDS> 1,785 22 1,218
0 0 0
0 0 0
<COMMON> 20 15 11
<OTHER-SE> 7,303 9,212 3,690
<TOTAL-LIABILITY-AND-EQUITY> 14,132 16,965 12,847
<SALES> 589 9,065 3,510
<TOTAL-REVENUES> 1,028 9,828 3,824
<CGS> 3,130 7,261 3,679
<TOTAL-COSTS> 17,707 19,023 13,632
<OTHER-EXPENSES> 0 0 0
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 587 359 715
<INCOME-PRETAX> (19,872) (16,456) (13,494)
<INCOME-TAX> 1 14 49
<INCOME-CONTINUING> (19,873) (16,470) (13,543)
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> (19,873) (16,470) (13,543)
<EPS-BASIC> (1.10) (1.29) (1.30)
<EPS-DILUTED> (1.10) (1.29) (1.30)
</TABLE>
