We recommend that you read this Report on Form 10-Q in conjunction with our Annual Report on Form 10-K for the year ended March 31, 2012.

Forward-looking Statements

This Form 10-Q contains "forward-looking statements" relating to projections, plans, objectives, estimates, and other statements of future economic performance. These forward-looking statements are subject to known and unknown risks and uncertainties relating to our future performance that may cause our actual results, performance, or achievements, or industry results, to differ materially from those expressed or implied in any such forward-looking statements. Our business operates in highly competitive markets and our ability to achieve the results implied by our forward looking statements is subject to changes in general economic conditions, competition, reimbursement levels, customer and market preferences, government regulation, the impact of tax regulation, foreign exchange rate fluctuations, the degree of market acceptance of products, the uncertainties of potential litigation, as well as other risks and uncertainties detailed elsewhere herein and in our Annual Report filed on Form 10-K for the year ended March 31, 2012.

We do not undertake, nor assume any obligation, to update any forward-looking statement that we may make from time to time.

Critical Accounting Policies

We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles, which require us to make estimates and assumptions in certain circumstances that affect amounts reported. In preparing these consolidated financial statements, we have made our best estimates and judgments of certain amounts, giving due consideration to materiality.

We have identified accounting policies that we consider particularly important for the portrayal of our results of operations and financial position and which may require the application of a higher level of judgment by our management, and as a result are subject to an inherent level of uncertainty. These are characterized as "critical accounting policies" and address revenue recognition, accounts receivable, inventories, foreign currency translation and transactions, impairment of long-lived assets, share-based compensation, defined benefit pension plans and income taxes, each of which is described in our Annual Report on Form 10-K for the year ended March 31, 2012. Based upon our review, we have determined that these policies remain our most critical accounting policies for the three-month period ended June 30, 2012, and we have made no changes to these policies during fiscal 2013.

Overview

We are a medical device company that develops, manufactures and markets innovative, proprietary products for the treatment of voiding dysfunctions. Our primary focus is on two products: the Urgent PC® Neuromodulation System, which we believe is the only FDA-cleared minimally invasive, office-based neuromodulation therapy for the treatment of overactive bladder (OAB) and associated symptoms of urinary urgency, urinary frequency, and urge incontinence; and Macroplastique® Implants a urethral bulking agent for the treatment of adult female stress urinary incontinence primarily due to intrinsic sphincter deficiency (ISD). Outside of the U.S., our Urgent PC System is also approved for treatment of fecal incontinence, and Macroplastique is also approved for treatment of male stress incontinence and vesicoureteral reflux.

Our sales during the past four years have been significantly influenced by the availability of third-party reimbursement for PTNS treatments. Sales of our Urgent PC System grew rapidly during fiscal 2007 and 2008 with rapid market acceptance of PTNS treatments that were reimbursed under a listed Current Procedure Technology (CPT®) code. However, during the first quarter of our fiscal 2009 the American Medical Association (AMA) advised the medical community that the previously recommended listed CPT code for reimbursement for PTNS treatments should be replaced with an unlisted CPT code. As a result, many third-party insurers delayed or denied reimbursement for PTNS treatments, and sales of our Urgent PC System in the U.S. declined from a peak of $2.2 million in the first quarter of our fiscal 2009 to a range of $0.9 million to $1 million per quarter in the six subsequent fiscal quarters ended December 2010.

We responded by sponsoring several randomized, controlled clinical studies over the following two years, and supported by publication of these clinical studies in U.S. peer-reviewed journals, we applied for, and effective January 2011 the AMA granted, a Category 1 CPT code for PTNS treatments. The AMA advised us of this decision prior to the effective date and we began to expand our sales organization in anticipation of increased interest in our Urgent PC. We have expanded our U.S. field sales and support organization from 15 employed sales representatives and six independent manufacturer's representatives on April 1, 2010 to 38 employed sales representatives and one independent manufacturer's representative on June 30, 2012.

We also focused our efforts on expanding reimbursement coverage with the Medicare carriers and private payers by instituting a comprehensive program to educate their medical directors regarding the clinical effectiveness, cost effectiveness and patient benefits of PTNS treatments using our Urgent PC System. As of June 30, 2012, eleven regional Medicare carriers representing 39 states and the District of Columbia, with approximately 36 million covered lives, provide coverage for PTNS treatments. In addition, we estimate that private payers providing insurance to approximately 84 million lives cover PTNS treatments.

With the availability of a CPT Category 1 code and expanded reimbursement coverage from third-party payers, as well as an expanded sales organization, our U.S. Urgent PC sales of $2.5 million during the quarter ended June 30, 2012 grew 64% over sales during the quarter ended June 30, 2011. In addition, because of the discontinuation in the marketplace of a competing product and our expanded sales organization, sales of our Macroplastique product in the U.S. of $1.5 million during the quarter ended June 30, 2012 grew 16% over sales during the quarter ended June 30, 2011.

At June 30, 2012, two regional Medicare carriers representing 11 states, with approximately 12 million covered lives, continued to decline reimbursement coverage for PTNS treatments. We are participating with a Medicare beneficiary who filed an administrative appeal for reconsideration of the decision of one of those regional Medicare carriers. That appeal remains pending.

The Centers for Medicare and Medicaid Services expects to continue to consolidate the regional Medicare claims administrators and there is no guarantee that Medicare beneficiaries in a region with reimbursement coverage will continue to be reimbursed when consolidated into a regional Medicare carrier with a negative reimbursement policy, or, if reimbursed, that coverage will remain unchanged. We continue to work with the medical directors of both Medicare and private payers to expand coverage of PTNS treatments, and to ensure that coverage continues after the number of Medicare regions is decreased and regional Medicare administrators are transitioned.

Results of Operations

Three months ended June 30, 2012 compared to three months ended June 30, 2011

Net Sales: During the three months ended June 30, 2012, consolidated net sales of $5.6 million represented a $0.9 million, or a 20% increase, over net sales of $4.7 million for the three months ended June 30, 2011.

The increase in consolidated net sales for the three months ended June 30, 2012 is attributed to the growth in U.S. sales.

Net sales to customers in the U.S. of $4.1 million during the three months ended June 30, 2012, represented an increase of $1.2 million, or 40%, over net sales of $2.9 million for the three months ended June 30, 2011.

Net sales in the U.S. of our Urgent PC product increased 64% to $2.5 million for three months ended June 30, 2012, from $1.5 million for the same period last year. Net sales increased because adoption and usage of the Urgent PC increased with the assignment of a new listed Category I CPT code effective January 2011 and expanded reimbursement coverage by third-party payers as well as the impact of our expanded direct sales organization.

In the fiscal first quarter ended June 30, 2012 we had 577 customers purchasing 3,283 lead set boxes, compared to 401 customers purchasing 1,985 lead set boxes in the first fiscal quarter of last year. In the fiscal fourth quarter ended March 31, 2012 we had 538 customers purchasing 3,023 lead set boxes. We are expanding the customer base and the customers have ramped-up their practice in light of the decision by several Medicare carriers and private payers to cover PTNS treatments using our Urgent PC.

Net sales in the U.S. of our Macroplastique product increased 16% to $1.5 million for the three months ended June 30, 2012, from $1.3 million for the same year-ago period. Net sales of our Macroplastique product increased over the corresponding period last year because of our increased sales and marketing focus on this product and the discontinuation in the marketplace of a competing product.

Net sales to customers outside the U.S. for the three months ended June 30, 2012 were $1.5 million compared to $1.8 million for the three months ended June 30, 2011, a decrease of 14%. Excluding the translation impact of fluctuations in foreign currency exchange rates, net sales decreased by approximately 6%. The decline in sales is primarily attributed to a decline in Macroplastique sales, offset partially by an increase in Urgent PC sales. Urgent PC sales of $556,000 for the three months ended June 30, 2012 increased 27% from $437,000 for the same period last year. Excluding the translation impact of fluctuations in foreign currency exchange rates, Urgent PC sales increased by approximately 38%.

Gross Profit: Gross profit was $4.8 million or 86.5% on net sales during the three months ended June 30, 2012, and $3.9 million, or 84.8% of net sales for the three months ended June 30, 2011. The increase in the gross profit percentage is attributed primarily to a favorable impact of approximately 0.5 percentage points from an increase in capacity absorption, a favorable impact of approximately 1.4 percentage points from product mix, offset partially by an unfavorable impact of the changes in the currency exchange rates on our foreign currency-denominated sales.

General and Administrative Expenses (G&A): G&A expenses of $1.1 million during the three months ended June 30, 2012, increased $70,000 from $1.0 million during the same period in 2011. G&A expenses increased primarily because of an increase in compensation costs.

Research and Development Expenses (R&D): R&D expenses of $563,000 during the three months ended June 30, 2012, increased $107,000 from $456,000 during the same period in 2011. The increase is attributed primarily to a $148,000 charge for product testing and validation of the planned replacement of components for one of our products, offset by a $66,000 decrease in clinical study costs.

Selling and Marketing Expenses (S&M): S&M expenses of $4.0 million during the three months ended June 30, 2012, increased $371,000 from $3.6 million during the same period in 2011. S&M expenses during the three months ended June 30, 2012, increased primarily because of an increase in compensation-related costs resulting from the increase in personnel in our U.S field sales and support organization and an increase in related travel expense for those employees.

Amortization of Intangibles: Amortization of intangibles was $216,000 and $212,000 for the three months ended June 30, 2012 and 2011, respectively.

Other Income (Expense): Other income (expense) includes interest income, foreign currency exchange and gains and losses and other non-operating costs when incurred. Net other income was $3,000 and $23,000 for the three months ended June 30, 2012 and 2011, respectively. Other income decreased as a result of a $5,000 decrease in interest income, and a $10,000 foreign currency exchange loss for the three months ended June 30, 2012 compared with a $5,000 foreign currency exchange gain for the three months ended June 30, 2011.

Income Tax Expense: During the three months ended June 30, 2012 and 2011, we recorded income tax expense of $8,000 and $14,000, respectively.

Non-GAAP Financial Measures: The following table reconciles our operating loss calculated in accordance with accounting principles generally accepted in the U.S. (GAAP) to non-GAAP financial measures that exclude non-cash charges for share-based compensation, and depreciation and amortization expenses from gross profit, operating expenses and operating loss. The non-GAAP financial measures used by management and disclosed by us are not a substitute for, or superior to, financial measures and consolidated financial results calculated in accordance with GAAP, and you should carefully evaluate our reconciliations to non-GAAP. We may calculate our non-GAAP financial measures differently from similarly titled measures used by other companies. Therefore, our non-GAAP financial measures may not be comparable to those used by other companies. We have described the reconciliations of each of our non-GAAP financial measures described above to the most directly comparable GAAP financial measures.

We use these non-GAAP financial measures, and in particular non-GAAP operating loss, for internal managerial purposes and incentive compensation for senior management because we believe such measures are one important indicator of the strength and the operating performance of our business. Analysts and investors frequently ask us for this information. We believe that they use these measures to evaluate the overall operating performance of companies in our industry, including as a means of comparing period-to-period results and as a means of evaluating our results with those of other companies.

Our non-GAAP operating loss during the three months ended June 30, 2012 and 2011 was approximately $561,000 and $934,000, respectively. The decrease in non-GAAP operating loss for the three months ended June 30, 2012 over the corresponding period a year ago is attributed to the increase in net sales and gross profit percent, which more than offset the increase in spending, primarily in selling and marketing.

                                                                      Expense Adjustments
                                                      Share-based                            Amortization
Three-Months Ended                      GAAP            Expense          Depreciation       of Intangibles       Non-GAAP
June 30, 2012
Gross Profit                        $  4,822,000     $        6,000     $        9,000                          $ 4,837,000
% of net sales                              86.5 %                                                                     86.7 %
Operating Expenses
General and administrative             1,092,000            (86,000 )          (47,000 )                            959,000
Research and development                 563,000            (12,000 )           (1,000 )                            550,000
Selling and marketing                  3,965,000            (60,000 )          (16,000 )                          3,889,000
Amortization                             216,000                                           $       (216,000 )             -
                                       5,836,000           (158,000 )          (64,000 )           (216,000 )     5,398,000

Operating Loss                      $ (1,014,000 )   $      164,000     $       73,000     $        216,000     $  (561,000 )

June 30, 2011
Gross Profit                        $  3,944,000     $        5,000     $        8,000                          $ 3,957,000
% of net sales                              84.8 %                                                                     85.0 %
Operating Expenses
General and administrative             1,022,000            (74,000 )          (40,000 )                            908,000
Research and development                 456,000             (8,000 )           (3,000 )                            445,000
Selling and marketing                  3,594,000            (45,000 )          (11,000 )                          3,538,000
Amortization                             212,000                                           $       (212,000 )             -
                                       5,284,000           (127,000 )          (54,000 )           (212,000 )     4,891,000

Operating Loss                      $ (1,340,000 )   $      132,000     $       62,000     $        212,000     $  (934,000 )

Liquidity and Capital Resources

Cash Flows.

At June 30, 2012, our cash and cash equivalents and short-term investments balances totaled $12.8 million. Our long-term investments at June 30, 2012 were $2.7 million.

At June 30, 2012, we had working capital of approximately $14.2 million.

For the three months ended June 30, 2012, we used $702,000 of cash in operating activities, compared to $1.4 million of cash used in the same period a year ago. We used this cash primarily to fund the operating loss, net of non-cash charges for depreciation, amortization of intangibles and equity compensation, of $561,000, and $934,000 in the respective periods. We have continued to show an operating loss because we have continued to invest, primarily in sales and marketing, to grow our U.S. business. We also used approximately $133,000 of cash to finance working capital necessary to support increased net sales, compared to $446,000 of cash used in the same period a year ago.

For the three months ended June 30, 2012, we used $74,000 in investing activities to purchase property, plant and equipment compared with approximately $71,000 for the same period a year ago.

Sources of Liquidity.

Uroplasty BV, our subsidiary in the Netherlands, has an agreement with Rabobank of The Netherlands for a €500,000 (approximately $629,000) credit line secured by our facility in Geleen, The Netherlands. The bank charges interest on the loan at the rate of one percentage point over the Rabobank base interest rate (4.3% base rate on June 30, 2012), subject to a minimum interest rate of 3.5% per annum. We had no borrowings outstanding on this credit line at June 30, 2012.

We believe we have sufficient liquidity to meet our needs for beyond the next twelve months. Although we have historically not generated cash from operations because we have yet to achieve profitability, we anticipate that we will become profitable and generate excess cash from operations prior to the full use of the current available cash and investments. To achieve this however, we must generate substantially more revenue than we have this year or in prior years.

Our ability to achieve significant revenue growth will depend, in large part, on our ability to achieve widespread market acceptance for our products and successfully expand our business in the U.S., which in turn may be partially dependent upon re-establishing broader reimbursement for our Urgent PC product. We cannot guarantee that we will be entirely successful at this. If we fail to meet our projections of profitability and cash flow, or determine to use cash for matters we have not currently projected, we may need to again seek financing to meet our cash needs. We cannot assure you that such financing, if needed, will be available to us on acceptable terms, or at all.

Commitments and Contingencies.

We discuss our commitments and contingencies in our Annual Report on Form 10-K for the year ended March 31, 2012. There have been no significant changes in our commitments for capital expenditure and contractual obligations since March 31, 2012.

We expect to continue to incur costs for clinical studies to support our ongoing marketing efforts and to meet regulatory requirements. We also expect to continue to incur significant expenses to support our U.S. sales and marketing organization, and for regulatory activities. In fiscal 2013 we started two multiyear studies: a pilot clinical study in the U.S, for the use of our Urgent PC for the treatment of fecal incontinence and a clinical study and product design for a minimally invasive implantable product for treatment of OAB. We estimate we will spend $0.8 million in fiscal 2013 for clinical studies.