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ULGX > SEC Filings for ULGX > Form 10-K on 20-Sep-2013All Recent SEC Filings

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Form 10-K for UROLOGIX INC


20-Sep-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with our financial statements and related notes contained elsewhere in this Annual Report on Form 10-K. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results and the timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of risks and uncertainties, including those set forth under "Risk Factors" in Item 1A. 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.

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 prostate 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 the 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!" campaign 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.

We continue to invest in research, development, and clinical trials to build upon our intellectual property, and our scientific and clinical knowledge to develop innovative future generations of BPH products and services. These investments are intended to improve our product offerings and expand the clinical evidence supporting each of our therapies for BPH. Our research and development efforts and goals are currently focused primarily on improving the features and functions of the technologies used in our Cooled ThermoTherapy and Prostiva RF Therapy procedures; improving the ease of use, patient comfort and clinical response to treatment; and also reducing the manufacturing cost of our products.


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We have incurred net losses of $4.3 million in fiscal year 2013, and $4.7 million and $3.7 million in the fiscal years ended 2012 and 2011, respectively. In addition, we have accumulated aggregate net losses since the inception of business through June 30, 2013 of $119.0 million. In the first quarter of fiscal year 2012 we entered into a license agreement with Medtronic and paid Medtronic $500,000 of the $1,000,000 initial license fee on September 6, 2011. On June 28, 2013, we entered into a Restructuring Agreement with Medtronic related to the $7.5 million in obligations we owed to Medtronic under the Transaction Documents. As part of this agreement we paid Medtronic $2.0 million in satisfaction of royalties earned for the 12 months ended September 6, 2012, the second half of the initial licensing fee, the license maintenance fee for the 12 month period ended September 6, 2012, for outstanding transition services fees, and for payment for Prostiva inventory included as part of the acquisition and purchased subsequent to the acquisition. In addition, we entered into a promissory note (the "Note") with Medtronic for $5.3 million for the remaining amounts owed on Prostiva inventory acquired as part of the acquisition and purchased subsequent to the acquisition. Interest on the Note will accrue at a rate of 6 percent, compounded annually and is payable in five equal installments of principal plus accrued interest on March 31stof each year beginning on March 31, 2015. The $206,000 difference between the $7.5 million in obligations owed to Medtronic and the $2.0 million paid and the $5.3 million Note was recorded as a gain on debt extinguishment. It was 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.

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, the $2.0 million payment to Medtronic in June 3013 for liabilities associated with the Prostiva acquisition, and the remaining liabilities related to the Prostiva acquisition and Note owed to Medtronic, 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, or if our cost reduction is not effective. 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 of August 20, 2013, we expect revenues in fiscal year 2014 to be in the range of $15 to $17 million. Our actual revenue results could differ materially from our expectation as a result of risks and uncertainties, including those set forth in Item 1A "Risks Factors" of this Form 10-K.

Critical Accounting Policies and Estimates:

In accordance with Securities and Exchange Commission guidance, we set forth below those material accounting policies that we believe are the most critical to an investor's understanding of our financial results and condition, and require complex management judgment.

Revenue Recognition

We recognize revenue from the sale of Cooled ThermoTherapy control units upon delivery to the customer, which include urologists, urology practices, mobile units, clinics and hospitals. We recognize revenue from the sale of Prostiva generators upon shipment to the customer. Revenue is recognized in accordance with generally accepted accounting principles as outlined in Accounting Standards Codification ("ASC") 605-10-S99, Revenue Recognition, which requires that four basic criteria be met before revenue can be recognized: (i) persuasive evidence of an arrangement exists; (ii) the price is fixed or determinable; (iii) collectability is reasonably assured; and (iv) product delivery has occurred or services have been rendered. The Company recognizes revenue as products are shipped based on FOB shipping point terms when title passes to customers. In addition to our sales of Cooled ThermoTherapy control units and Prostiva generators, we place our control units and generators with customers free of charge under a variety of programs for both evaluation and long-term use, and also provide access to Cooled ThermoTherapy and Prostiva RF Therapy treatments via our Urologix mobile service. We retain title to the control units and generators placed with our customers for evaluation and longer-term use. These programs, as well as our Urologix mobile service, are designed to expand access to our technology, and thus expand the market for our single-use treatment catheters and Prostiva handpieces. The free use of our Cooled ThermoTherapy control units and Prostiva generators are bundled with the sale of single-use treatment catheters or Prostiva handpieces and scopes, respectively, and are considered a single unit of accounting. Revenue from the bundled sales is recognized when the single-use treatment catheters or handpieces and scopes are shipped to our customers. Revenue from our mobile service is recognized upon treatment of the patient. Revenue for extended warranty service contracts is deferred and recognized over the contract period on a straight-line basis. We record a provision for estimated sales returns on product sales in the same period as the related revenue is recorded. The provision for estimated sales returns is based on historical sales returns, analysis of credit memo data and specific customer-based circumstances. Should actual sales returns differ from our estimates, revisions to the sales return reserve would be required. Sales and use taxes are reported on a net basis, excluding them from revenue.


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Inventories

We value our inventories, consisting primarily of control units, single-use treatment catheters, and raw materials to produce the control units and treatment catheters, at the lower of cost or market value on a first-in, first-out ("FIFO") basis. The inventory cost includes merchandise, labor, overhead and freight. A periodic review of the inventory on hand is performed to determine if the inventory is properly stated at the lower of cost or market. In performing this analysis we consider, at a minimum, the following factors:
average selling prices, reimbursement changes, and changes in demand for our products due to competitive conditions or market acceptance. Each type of inventory is analyzed to determine net realizable values. A provision is recorded to reduce the cost of inventories to the estimated net realizable values, if required (a new cost basis).

We also analyze the level of inventory on hand on a periodic basis, in relation to estimated customer requirements to determine whether write-downs for excess, obsolete, or slow-moving inventory are required. Any significant or unanticipated change in the factors noted above could have a significant impact on the value of our inventories and on our reported operating results.

Valuation of Long-Lived Assets and Goodwill

We assess the impairment of long-lived assets whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An asset or asset group is considered impaired if its carrying amount exceeds the undiscounted future net cash flows the asset or asset group is expected to generate. If an asset or asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds its fair value. If estimated fair value is less than the book value, the asset is written down to the estimated fair value and an impairment loss is recognized.

Goodwill is tested for impairment annually on April 30th or more frequently if changes in circumstance or the occurrence of events suggests an impairment may exist. To determine if there is goodwill impairment, the fair value of the reporting unit is compared to its carrying amount. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the fair value of the goodwill is less than the carrying value of the goodwill. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows.

Considerable management judgment is necessary in estimating future cash flows and other factors affecting the valuation of long-lived assets and goodwill, including the operating and macroeconomic factors that may affect them. We use historical financial information, internal plans and projections and industry information in making such estimate.

As a result of the delisting of our common stock from the NASDAQ exchange on June 7, 2013 and the continued decline of our stock price, we tested our long-lived assets and goodwill for impairment as of June 30, 2013. Based on this impairment testing it was determined that our intangible assets acquired as part of the Prostiva acquisition were impaired. As a result, we recorded an impairment charge of $274,000 on our developed technology asset which was recorded in cost of goods sold, a $95,000 impairment charge on our customer base asset and a $65,000 impairment charge on trademarks both of which were recorded in operating expense. There was no impairment of goodwill as it was determined that the fair value of the reporting unit exceeded its carrying amount as of June 30, 2013. See Footnote 11 for a description of our intangible assets and the impairment charges recorded as of June 30, 2013.


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Income Taxes

We utilize the asset and liability method of accounting for income taxes. We recognize deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities. We regularly assess the likelihood that our deferred tax assets will be recovered from future taxable income. We consider projected future taxable income and ongoing tax planning strategies in assessing the amount of the valuation allowance necessary to offset our deferred tax assets that will not be recoverable. We have recorded and continue to carry a full valuation allowance against our gross deferred tax assets that will not reverse against deferred tax liabilities within the scheduled reversal period. If we determine in the future that it is more likely than not that we will realize all or a portion of our deferred tax assets, we will adjust our valuation allowance in the period we make the determination. We expect to provide a full valuation allowance on our future tax benefits until we can sustain a level of profitability that demonstrates our ability to realize these assets. At June 30, 2013, we carried a valuation allowance of $30.2 million against our net deferred tax assets.

Stock-Based Compensation

The Company uses the fair value recognition provisions of the revised authoritative guidance for equity-based compensation and applies the modified prospective method in determining stock compensation expense. Stock compensation expense is based on the fair value of the award at the date of grant and is recognized over the requisite service period which corresponds to the vesting period. Options and restricted stock awards typically vest 25 percent after the first year of service with the remaining vesting 1/36theach month thereafter. Generally, options granted to non-employee directors are immediately exercisable at the date of grant while restricted stock awards generally vest after one year. Options are priced based on the closing price of a share of our common stock at the date of grant. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. To determine the inputs for the Black-Scholes option pricing model, we use historical data to estimate expected volatility and the period of time that option grants are expected to be outstanding. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. The range of these assumptions and the range of option pricing and number of options granted at the different grant dates will impact our calculation of the fair value of the awards and will therefore impact the amount of expense reflected in our statement of operations for any given period. Fair value for restricted stock is based on the market price on the day of grant.

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

Fiscal Years Ended June 30, 2013 and 2012

Net Sales

Net sales decreased 3 percent to $16.6 million in fiscal year 2013 from $17.0 million in fiscal year 2012. The decrease in sales from fiscal year 2012 is due to a slight decline in sales of our Cooled ThermoThearpy product line of $709,000, partially offset by a slight increase in sales of our Prostiva product line of $271,000. The increase in sales of our Prostiva product line was a result of a full year of Prostiva sales in fiscal year 2013 compared to only approximately ten months of sales in fiscal 2012 as a result of the Prostiva acquisition on September 6, 2011.


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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 Cooled ThermoTherapy mobile service, as well as costs for the Prostiva products. Cost of goods sold for fiscal year 2013 decreased $238,000 or 3 percent to $8.4 million, from $8.6 million in fiscal year 2012. This decrease in cost of goods sold is a result of the decrease in sales year over year as well as better absorption of manufacturing expenses and reductions in royalty expenses which expired at the end of fiscal 2012. These decreases were partially offset by a $274,000 impairment charge related to the developed technologies acquired in the Prostiva acquisition.

Gross profit as a percentage of sales remained consistent at 49 percent in fiscal years 2013 and 2012. The fiscal year 2013 gross margin percentage was impacted by 2 percentage points as a result of the $274,000 developed technology impairment charge mentioned above.

Sales and Marketing

Sales and marketing expenses in fiscal year 2013 increased $692,000, or 10 percent, to $7.7 million from $7.0 million in fiscal year 2012. The increase in sales and marketing expense is the result of a $674,000 increase in wages and benefits, including commissions, as a result of the expansion of the sales force from the Prostiva acquisition which occurred at the end of the first quarter of fiscal 2012.

General & Administrative

General and administrative expense in fiscal year 2013 decreased $878,000, or 26 percent, to $2.5 million from $3.4 million in fiscal year 2012. The decrease in general and administrative expense is mainly a result of a decrease in legal and audit fees of $333,000 as a result of one-time expenses related to the Prostiva transaction in fiscal 2012. The remaining decrease largely relates to a $337,000 decrease in non-cash accretion expense on the contingent deferred acquisition payments as a result of a shift of accretion expense from general and administrative expenses to interest expense in the current fiscal year as a result of the restructuring of Medtronic liabilities.

Research and Development

Research and development expenses, which include expenditures for product development, regulatory compliance and clinical studies, increased slightly to $2.3 million for fiscal year 2013, from $2.2 million in fiscal year 2012. The $80,000, or 4 percent, increase in research and development expense is due to an increase in product testing and project materials of $37,000, a $28,000 increase in recruiting fees, as well as an increase of $21,000 in consulting expenses, net of compensation expense savings as a result of open headcount positions.

The fiscal year 2013 research and development expenses includes $206,000 of transition services fees that were not paid as a result of the Restructuring Agreement entered into on June 28, 2013 with Medtronic. The non-payment of these fees was recorded in a separate line as a gain on debt extinguishment in our Statements of Operations.

Change in Value of Acquisition Consideration

The change in the value of acquisition consideration of $447,000 for the fiscal year ended June 30, 2013 represents the net effect of a reduction in fair value of contingent consideration of $1.4 million, partially offset by an increase of $933,000 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, and reduced the projected royalty payments in excess of contractual minimums in earlier years.


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Gain on Demutualization

The one-time gain on demutualization of $321,000 for the fiscal year ended June 30, 2013 represents the gain resulting from the demutualization of our products liability insurance carrier.

Medical Device Tax

The medical device excise tax expense of $106,000 for the fiscal year ended June 30, 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 approximately $104,000 in fiscal years 2013 compared to $90,000 in fiscal year 2012. The increase in the amortization expense of $14,000 is a result of having a full year of amortization expense related to the intangible assets acquired as part of the Prostiva acquisition, compared to only 10 months in the previous fiscal year.

Impairment of Identifiable Intangible Assets

We recorded an impairment charge of $160,000 on identifiable intangible assets in fiscal year 2013. The impairment charge relates to a $95,000 write-down of the customer base and a $65,000 write-down of the trademarks acquired as part of the Prostiva acquisition.

Net Interest Income/(Expense)

Net interest expense of approximately $555,000 for the fiscal year ended June 30, 2013, increased $73,000 over interest expense of $482,000 for the fiscal year ended June 30, 2012. Interest expense represents the non-cash interest accretion on the non-contingent deferred acquisition payments. The increase in interest expense is a result of a shift of accretion expense from general and administrative expenses to interest expense in the current fiscal year as a result of the restructuring of Medtronic liabilities.

Gain on Debt Extinguishment

The one-time gain on debt extinguishment of $206,000 is a result of the Restructuring Agreement entered into on June 28, 2013 with Medtronic which resulted in the restructuring of $7.5 million in outstanding Prostiva liabilities into a $2.0 million cash payment and a $5.3 million promissory note.

Provision for Income Taxes

We recorded $14,000 of income tax expense for the fiscal year ended June 30, 2013 compared to income tax expense of $55,000 for the fiscal year ended June 30, 2012. The decrease in income tax expense of $41,000 is mainly the result of adjustments to the deferred tax liability resulting from the amortization of goodwill for tax purposes created in the Prostiva acquisition in the current fiscal year, partially offset by state taxes.

The Company utilizes the asset and liability method of accounting for income taxes. The Company recognizes deferred tax liabilities or assets for the expected future tax consequences of temporary differences between the book and tax basis of assets and liabilities. We have recorded and continue to carry a full valuation allowance against our gross deferred tax assets that will not reverse against deferred tax liabilities. We will continue to assess the assumptions used to determine the amount of our valuation allowance and may adjust the valuation allowance in future periods based on changes in assumptions of estimated future income and other factors.


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Fiscal Years Ended June 30, 2012 and 2011

Net Sales

Net sales increased 35 percent to $17.0 million in fiscal year 2012 from $12.6 million in fiscal year 2011. The increase in sales from fiscal year 2011 is due to the addition of Prostiva product sales after the completion of the acquisition on September 6, 2011.

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 Cooled ThermoTherapy mobile service, as well as costs for the newly acquired Prostiva products. Cost of goods sold for fiscal year 2012 increased to $8.6 million, or . . .

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