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ULGX > SEC Filings for ULGX > Form 10-Q on 14-May-2013All Recent SEC Filings

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Form 10-Q for UROLOGIX INC


14-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management's Discussion and Analysis of Financial Condition and Results of Operations contains, in addition to historical information, forward-looking statements that are based on our current expectations, beliefs, intentions or future strategies. These statements are subject to risks and uncertainties that could cause actual results to differ materially from the statements as a result of certain factors, including those set forth under Part I, Item 1A. "Risk Factors" in our Annual Report on Form 10-K for the year ended June 30, 2012 and those set forth under Part II, Item 1A, "Risk Factors" of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, as well as in other filings we make with the Securities and Exchange Commission and include factors such as: as a result of our history of operating losses and inadequate operating cash flow, there is substantial doubt about our ability to continue as a going concern; we have a history of unprofitability and may not be able to generate sufficient cash flow to fund our operations; we may need additional capital to continue our business and any additional capital we seek may not be available in the amount or at the time we need it; third party reimbursement is critical to market acceptance of our products; we are faced with intense competition and rapid technological and industry change; all of our revenues are derived from minimally invasive therapies that treat one disease, BPH; government regulation has a significant impact on our business; we are dependent upon a limited number of third-party suppliers for our products; our business of the manufacturing, marketing, and sale of medical devices involves the risk of liability claims and such claims could seriously harm our business, particularly if our insurance coverage is inadequate; we are dependent on adequate protection of our patent and proprietary rights; our products may be subject to product recalls even after receiving FDA clearance or approval, which would harm our reputation and our business; we are dependent on key personnel; we do not comply with Nasdaq listing requirements and have received an extension from The Nasdaq Stock Market to regain compliance with listing requirements, however if we fail to regain compliance in the extension period granted, our common stock will be delisted from The Nasdaq Capital Market and become illiquid; fluctuations in our future operating results may negatively affect the market price of our common stock; our stock price may be volatile and a shareholder's investment could decline in value; future sales of shares of our common stock may negatively affect our stock price; provisions of Minnesota law, our governing documents and other agreements may deter a change of control of us and have a possible negative effect on our stock price; the license for the Prostiva RF Therapy System could result in operating difficulties and other harmful consequences that may adversely impact our business and results of operations; if we fail to comply with our obligations under our license agreement with Medtronic or if the license agreement terminates for any reason, we could lose the ability to see the Prostiva product; the Prostiva RF Therapy System license and other agreements require significant future payments; because we have not made certain payments under our license agreement with Medtronic pending negotiations relating to its terms, we may lose the ability to sell the Prostiva product and if we made all required payments, our available cash would be depleted substantially; and the addition of the Prostiva RF Therapy System to our product portfolio may result in the aggravation of certain risks to our business. All forward-looking statements included herein are based on information available to us as of the date hereof, and we undertake no obligation to update any such forward-looking statements.

The following is a discussion and analysis of Urologix' financial condition and results of operations as of and for the three and nine-months ended March 31, 2013 and 2012. This section should be read in conjunction with the condensed financial statements and related notes in Item 1 of this report and Urologix' Annual Report on Form 10-K for the year ended June 30, 2012.

OVERVIEW

Urologix develops, manufactures, and markets non-surgical, office-based therapies for the treatment of the symptoms and obstruction resulting from non-cancerous prostate enlargement also known as benign prostatic hyperplasia (BPH). These therapies use proprietary technology in the treatment of BPH, a disease that affects more than 30 million men worldwide and is the most common urologic problem for men over 50. We market both the Cooled ThermoTherapy™ (CTT) product line and the Prostiva® Radio Frequency (RF) Therapy System. We acquired the exclusive worldwide license to the Prostiva® RF Therapy System in September 2011. These two technologies are designed to be used by urologists in their offices without placing their patients under general anesthesia. CTT uses a flexible catheter to deliver targeted microwave energy combined with a unique cooling mechanism that protects healthy urethral tissue and enhances patient comfort to provide safe, effective, lasting relief from BPH voiding symptoms by the thermal ablation of hyperplastic prostatic tissue surrounding the urethra. The proprietary Prostiva® RF Therapy System delivers radio frequency energy directly into the prostate through the use of insulated electrodes deployed from a transurethral scope, ablating targeted prostatic tissue under the direct visualization of the urologist. These focal ablations reduce constriction of the urethra, thereby relieving BPH voiding symptoms. These two proven technologies have slightly different, yet complementary, patient indications and providing them to our urologist customers enables them to treat a wide range of patients in their office. We believe that these office-based BPH therapies are efficacious, safe and cost-effective solutions for BPH as they have shown results clinically superior to those of medication based treatments and without the complications and side effect profile inherent with surgical procedures.


Our goal is to grow our business by establishing Cooled ThermoTherapy and Prostiva RF Therapy as the preferred therapeutic options considered by urologists for their BPH patients in the earlier stages of disease progression who do not want to take chronic BPH medication or are unhappy with their BPH medication's side effects, costs or results. A urologist can choose between our two therapies based upon clinical criteria specific to the BPH patient's presentation. Our business strategy to achieve this goal is to:

• Educate patients and urologists on the benefits of Cooled ThermoTherapy and Prostiva RF Therapy through the Company's "Think Outside the Pillbox!" and other market development efforts,

• Increase utilization of Cooled ThermoTherapy and Prostiva RF Therapy by urologists who already have access to a Cooled ThermoTherapy and/or Prostiva RF Therapy system,

• Increase the number of urologists who utilize one or both of our therapy treatment options for their patients,

• Continue to partner with our European distributors to support the customers outside the United States, and

• Pursue other technologies to add to our portfolio that fit our brand, distribution channels and clinical standards through acquisition or other partnering structures.

Our marketing and patient education efforts are focused on three goals: (i) increasing urologist adoption of both technologies and optimizing patient selection for maximum patient benefit and appropriate utilization; (ii) increasing patient awareness of office based treatment options; and (iii) exposing urologists to the significant patient need for effective alternatives to medical management that are non-surgical. We employ specific tools to support each of these goals. For the first, this includes developing a well trained clinically oriented sales force that can explain both technologies and patient selection criteria and arming them with the tools and knowledge to be successful. For the second and third, our primary platform for raising patient awareness and increasing urologist exposure to the patient need is through the "Think Outside the Pillbox" campaign. We have had repeated success with this effort with strong patient responses to our call to action and urologists impressed with the turnout at the educational events. The result of these activities on our business is that the accounts that participate in this program have increased utilization, measured by revenue per account, after the campaign compared to before. We have increased our investment in our sales and marketing programs in an effort to improve the visibility of our products and increase revenues.

During the second quarter of fiscal year 2012, we initiated sales of the Prostiva RF Therapy system in Europe by entering into supply agreements with distributors in targeted countries. Total international Prostiva sales for the three and nine-month periods ended March 31, 2013 were $136,000 and $420,000, respectively, or approximately 3 percent of sales for both the three and nine-month periods.

We believe that third-party reimbursement is essential to the continued adoption of Cooled ThermoTherapy and Prostiva RF Therapy, and that clinical efficacy, overall cost-effectiveness and physician advocacy will be keys to maintaining such reimbursement. We estimate that 70% to 80% of patients who receive Cooled ThermoTherapy and Prostiva RF Therapy treatment in the United States are eligible for Medicare coverage. The remaining patients are covered by either private insurers, including traditional indemnity health insurers and managed care organizations, or are private paying patients. As a result, Medicare reimbursement is particularly critical for widespread and ongoing market adoption of Cooled ThermoTherapy and Prostiva RF Therapy in the United States.

Each calendar year the Medicare reimbursement rates for all procedures, including Cooled ThermoTherapy and Prostiva RF Therapy, are determined by the Centers for Medicare and Medicaid Services (CMS). The Medicare reimbursement rate for physicians varies depending on the procedure type, site of service, wage indexes and geographic location. The national average reimbursement rate is the fixed rate for the year without any geographic adjustments, but does vary based on site of service. Cooled ThermoTherapy and Prostiva RF Therapy can be performed in the urologist's office, an ambulatory surgery center (ASC), or a hospital as an outpatient procedure.

CMS published their final rule in November 2012 for implementation during calendar year 2013. In addition, in January of 2013, the government acted to keep the Sustainable Growth Rate (SGR) from taking effect as part of the Taxpayer Relief Act. The final rule and the impacts from the Taxpayer Relief Act resulted in an average reimbursement rate in the physician office setting for calendar year 2013 of $2,102 for Cooled ThermoTherapy and $1,933 for Prostiva RF Therapy. In addition, beginning April 1, 2013, there is an additional 2 percent reduction to all Medicare payments to providers that is a result of the Sequester. It is unclear how long this incremental reduction will remain in effect.

Cooled ThermoTherapy and Prostiva RF Therapy procedures are also reimbursed when performed in an ASC or a hospital outpatient setting, but these are a small portion of our business and the CMS rates will not have a material effect on our financial performance.


Private insurance companies and HMOs make their own determinations regarding coverage and reimbursement based upon "usual and customary" fees. To date, we have received coverage and reimbursement from private insurance companies and HMOs throughout the United States. We intend to continue our efforts to maintain coverage and reimbursement across the United States. There can be no assurance that reimbursement determinations for either Cooled ThermoTherapy or Prostiva RF Therapy from these payers for amounts reimbursed to urologists to perform these procedures will be sufficient to compensate urologists for use of Urologix' product and service offerings.

Internationally, reimbursement approvals for the Cooled ThermoTherapy and Prostiva procedures are awarded on an individual-country basis.

As a result of recently enacted Federal health care reform legislation, substantial changes are anticipated in the United States health care system. Such legislation includes numerous provisions affecting the delivery of health care services, the financing of health care costs, reimbursement of health care providers and the legal obligations of health insurers, providers and employers. These provisions are currently slated to take effect at specified times over the next decade. The Federal health care reform legislation did not directly affect our fiscal year 2012 financial statements. However, beginning in January 2013, the legislation imposed significant new taxes on medical device makers in the form of a 2.3% excise tax on all U.S. medical device sales. As a result, we incurred approximately $41,000 in medical device excise tax for the three-month period ended March 31, 2013. This significant increase in the tax burden on our industry could have a material, negative impact on our results of operations and our cash flows.

We will continue to fund product development efforts and clinical research to improve and support our products and therapies. These investments are intended to improve our product offerings and expand the clinical evidence supporting each of our therapies for BPH: Cooled ThermoTherapy and Prostiva RF Therapy. We continue to highlight our products' published five-year durability and cost effectiveness data, as well as the ability of urologists using our systems to customize each treatment for each patient.

We have incurred net losses of $3,045,000 for the nine-months ended March 31, 2013 and $4,695,000 and $3,733,000 in the fiscal years ended June 30, 2012 and 2011, respectively. In addition, the Company has accumulated aggregate net losses from the inception of business through March 31, 2013 of $117,771,000. During the first quarter of fiscal 2012, the Company entered into a license agreement with Medtronic for the Prostiva RF Therapy System. The Company paid Medtronic $500,000 on September 6, 2011 for half of the $1,000,000 initial license fee, with the remaining $500,000 payable on September 6, 2012. The Company did not pay the second half of the initial licensing fee pending continuing discussions with Medtronic. This payable is included in the deferred acquisition payment liability as of March 31, 2013. As part of the licensing agreement, royalty payments for Prostiva products are paid one year in arrears based on the contract year; these amounts, which were due in October 2012, were also not paid. In addition, inventory payments were deferred on both inventory transferred upon the close of the agreement and on shipments of products purchased subsequent to the agreement, which total $6.1 million as of March 31, 2013. The royalty payment due on October 6, 2012 and deferred payments on inventory transferred as part of the acquisition have also not been paid because of the continuing discussions with Medtronic and are included in the short-term deferred acquisition payment liability as of March 31, 2013. Deferred payments on inventory purchased subsequent to the close of the transaction through March 31, 2013 are included in accounts payable and approximate $4.7 million. It is the Company's preference to extend the payment terms to Medtronic as long as possible in order to allow us to deploy our cash resources to turnaround the Prostiva business and implement our market development strategy.

Through March 31, 2013, we have not paid approximately $1.3 million due to Medtronic for the second half of the initial licensing fee due in September 2012, royalty payment due in October 2012, license maintenance fees due in September 2012, and monthly transition service fees. Through March 31, 2013, we also have not paid amounts due relating to approximately $3.0 million in product received. The total amount due and unpaid to Medtronic under the Prostiva related agreements is therefore $4.3 million, of which approximately $1.6 million is included in the deferred acquisition payment liability and of which approximately $2.7 million is included in accounts payable.

The Company does not deem the payments owed Medtronic to be in default as discussions are ongoing with Medtronic and Medtronic has not provided the required notice of breach (which allows for an opportunity to cure).

During the quarter ended September 30, 2012, the Company completed a follow-on offering in which we sold 5,980,000 shares of common stock at a price of $0.75 per share which contributed approximately $3.8 million of net proceeds after deducting underwriting discounts and commissions and other expenses payable by the Company. However, as a result of the Company's history of operating losses and negative cash flows from operations, and the licensing fee, royalties and inventory payments related to the Prostiva acquisition, there is substantial doubt about our ability to continue as a going concern. Our cash, cash generated from operations, if any, and available borrowings under our agreement with Silicon Valley Bank, may not be sufficient to sustain day-to-day operations for the next 12 months, particularly if product sales do not generate revenues in the amounts currently anticipated, if our operating costs are greater than anticipated or greater than our business can support, if our planned cost reduction is not effective or if we are required to pay amounts currently due under the Prostiva related agreements without reduction, postponement or other restructuring. Our ability to continue as a going concern is dependent upon improving our liquidity. The Company may seek to improve its liquidity position by raising capital through additional indebtedness or an offering of its equity securities or both.


Our financial statements do not include any adjustments related to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that may be necessary as a result of this uncertainty.

As stated in our press release on May 1, 2013, we expect revenues in fiscal year 2013 to be in the range of $16 to $17 million.

Critical Accounting Policies:

A description of our critical accounting policies was provided in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of our Annual Report on Form 10-K for the year ended June 30, 2012. At March 31, 2013, our critical accounting policies and estimates continue to include revenue recognition, inventories, valuation of long-lived assets and goodwill, income taxes, and stock-based compensation. As discussed in Note 8, due to reductions in our long-term revenue expectations for the Prostiva business, an impairment trigger occurred for long-lived assets and goodwill in the second quarter of fiscal 2013, however, no impairment was identified for the Company's single reporting unit and asset group. If the long-term revenue expectations continue to decrease or market capitalization decreases, the Company may have to record impairment of long-lived assets and/or goodwill. In addition, as of March 31, 2013, our critical accounting policies also include fair value of contingent consideration as follows:

Fair Value of Contingent Consideration
Contingent consideration is recorded at the acquisition date at the estimated fair value of the future royalty payments in excess of contractual minimums. The acquisition date fair value is measured based on the consideration expected to be transferred discounted back to present value. The discount rate used is determined at the time of measurement in accordance with accepted valuation methods. The fair value of the contingent consideration is remeasured to the estimated fair value at each reporting period with the change in fair value recognized as gain or loss in our statement of operations. Changes to the fair value of the contingent consideration liability occur as a result of changes in discount rates and changes in the timing and amount of projected payments.

RESULTS OF OPERATIONS

Net Sales
Net sales for the three-months ended March 31, 2013 were $4.1 million, compared to $4.7 million during the same period of the prior fiscal year. The $653,000, or 14 percent, decrease in net sales for the comparable prior year period is primarily the result of a decrease in orders for both Prostiva US sales as well as Cooled ThermoTherapy sales.

Net sales for the nine-months ended March 31, 2013 were $12.4 million, compared to $12.5 million for the nine-months ended March 31, 2013. The decrease in net sales of $125,000, or one percent is again the result of a decrease in orders of Prostiva US sales and Cooled ThermoTherapy sales. This decrease was partially offset by having a full nine months of Prostiva revenue compared to only seven months in the prior year period.

Cost of Goods Sold and Gross Profit
Cost of goods sold includes raw materials, labor, overhead, and royalties incurred in connection with the production of our Cooled ThermoTherapy system control units and single-use treatment catheters, amortization related to developed technologies, costs associated with the delivery of our Urologix mobile service, as well as costs for the Prostiva products. Cost of goods sold for the three-months ended March 31, 2013 decreased $278,000, or 12 percent, to $2.1 million, from $2.3 million for the three-month period ended March 31, 2012. The decrease in costs of goods sold for the three-months ended March 31, 2013 is primarily a result of the decrease in sales, partially offset by higher control unit manufacturing costs. Costs of goods sold of $6.1 million for the nine-month period ended March 31, 2013 decreased by $298,000 or 5 percent from $6.4 million reported for the nine-month period ended March 31, 2012. The decrease in cost of goods sold is the result of better absorption of manufacturing expenses as a result of increased production when compared with the prior year period, as well as a decrease in royalty expenses from license agreements that expired at the end of fiscal 2012.

Gross profit as a percentage of net sales decreased to 50 percent from 51 percent for the three-month periods ended March 31, 2013 and 2012, respectively. The decrease in the gross profit rate for the three-month period ended March 31, 2013 is a result of variability in control unit manufacturing expenses, as well as a positive impact from a change in the inventory obsolescence reserve in the prior year period. Gross profit as a percentage of net sales increased to 51 percent from 49 percent for the nine-month periods ended March 31, 2013 and 2012, respectively. The increase in the gross margin rate for the nine-month period ended March 31, 2013 is due to the improved absorption and lower royalty expenses noted above.


Sales and Marketing
Sales and marketing expense of $1.9 million for the third quarter of fiscal 2013 increased slightly by $40,000, or 2 percent, when compared to sales and marketing expense of $1.9 million in the same period of fiscal 2012. The increase in sales and marketing expense for the three-months ended March 31, 2013 is largely due to increases in advertising and promotions of $121,000 mainly related to our patient education campaign, as well as headcount related expenses of $63,000 as a result of continued investment in our sales force. These increases were partially offset by lower bad debt expense in the current year period as well as lower convention and meeting expenses.

Sales and marketing expense of $5.6 million for the nine-month period ended March 31, 2013 increased $725,000, or 15 percent, when compared to sales and marketing expense of $4.9 million in the same period of fiscal 2012. The increase in sales and marketing expense year-over-year is largely due to increased compensation expense of $494,000 as a result of the expansion of the sales force from the Prostiva acquisition in September 2011. In addition, marketing expense increased $453,000, related to our patient education campaign and additional advertising spending. These increases were again partially offset by lower convention and meeting expenses and lower bad debt expenses in the current year.

General and Administrative
General and administrative expense decreased $86,000, or 11 percent, to $711,000 for the three-month period ended March 31, 2013 compared to $797,000 for the three-month period ended March 31, 2012. The decrease in general and administrative expense is mainly a result of a decrease in legal and audit fees of $44,000 as well as a $39,000 decrease in headcount related expenses.

For the nine-months ended March 31, 2013, general and administrative expense decreased $497,000 or 19 percent to $2.1 million from $2.6 million for the nine-month period ended March 31, 2012. The decrease in general and administrative expense is again a result of a decrease in legal and audit fees and consulting fees of $343,000 related to the Prostiva transaction in the prior year, as well as a $69,000 decrease in the sales tax accrual as a result of the resolution of outstanding sales tax issues in certain states.

Research and Development
Research and development expense, which includes expenditures for product development, regulatory compliance and clinical studies, remained consistent at $538,000 for the three-month period ended March 31, 2013, compared to $543,000 for the three-month period ended March 31, 2012.

For the nine-months ended March 31, 2013, research and development expense increased $144,000 or 9 percent to $1.8 million from $1.6 million for the nine-month period ended March 31, 2012. The increase in research and development expense year-over-year is a result of a $74,000 increase in consulting expenses, net of compensation expense savings as a result of open headcount positions, as well as a $53,000 increase related to product testing.

Change in Value of Acquisition Consideration The change in the value of acquisition consideration was $0 and $369,000 for the three and nine-month periods ended March 31, 2013. For the three-month period ended March 31, 2013, there was no change in the value of acquisition consideration. For the nine-month period ended March 31, 2013, the change in the value of acquisition consideration represents the net effect of a reduction in fair value of contingent consideration of $791,000, partially offset by an increase of $422,000 in non-contingent consideration. These changes are due to an increase in the projected time it will take the Company to reach the cumulative $10 million of royalty and license fees owed on the Prostiva acquisition, which increased the number of years subject to minimum royalty payments and reduced the projected royalty payments in excess of contractual minimums in earlier years.

Gain on Demutualization
The one-time gain on demutualization of $321,000 for the three and nine-month periods ended March 31, 2013 represents the gain resulting from the demutualization of our products liability insurance carrier.

Medical Device Tax
The medical device excise tax expense of $41,000 for the three and nine-month periods ended March 31, 2013 represents the excise tax imposed beginning January 1, 2013 on all U.S. medical device sales as part of the Federal health care reform legislation.

Amortization of Identifiable Intangible Assets Amortization of identifiable intangible assets was $26,000 for the three-month period ended March 31, 2013 and 2012. Amortization of identifiable intangible assets for the nine-month period ended March 31, 2013 increased $13,000 to $78,000 compared to $65,000 in the prior fiscal year period. The increase in the amortization expense for the nine-month period ended March 31, 2013 is a result of a full nine months of amortization expense on the intangible assets acquired as part of the Prostiva acquisition, compared to only seven . . .

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