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ULGX > SEC Filings for ULGX > Form 10-Q on 13-Feb-2014All Recent SEC Filings

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Form 10-Q for UROLOGIX INC


13-Feb-2014

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, 2013 and those set forth under Part II, Item 1A, "Risk Factors" of this Quarterly Report on Form 10-Q for the quarter ended December 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; our common stock was recently transferred from The NASDAQ Captial Market ("NASDAQ") to the OTC Markets Group's OTCQB which could impair our ability to raise capital and will likely hinder our investors' ability to trade our common stock in the secondary market; 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; 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; our business, financial condition, results of operations and cash flows could be significantly and adversely affected by recent healthcare reform legislation, including, most immediately, by the medical device excise tax that was effective January 1, 2013; 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; 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, Restructuring Agreement and other agreements require significant future payments; the addition of the Prostiva RF Therapy System to our product portfolio may result in the aggravation of certain risks to our business; we have not paid certain amounts due to Medtronic under the license agreement, which with proper notice and opportunities to cure would entitle Medtronic to terminate the license agreement for breach constitute an event of default under our $5.3 million promissory note to Medtronic; and it is an event of default to make payments of these amounts to Medtronic under the terms of the third amendment to the loan and security agreement with Silicon Valley Bank although we may cure this event of default by completing an equity or subordinated debt financing. 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 six-months ended December 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, 2013.

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.

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 non-surgical alternatives to medical management. 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 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 six-month periods ended December 31, 2013 and 2012 were $100,000 and $147,000, respectively, and $165,000 and $285,000, respectively.

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 2013 for implementation during calendar year 2014 and the government acted to keep the Sustainable Growth Rate (SGR) from taking effect. The final rule resulted in an average reimbursement rate in the physician office setting for calendar year 2014 of $2,063 for Cooled ThermoTherapy and $1,899 for Prostiva RF Therapy. 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, beginning in January 2013, 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 $59,000 and $119,000, respectively, in medical device excise tax for the three-and six month periods ended December 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 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; reducing the manufacturing cost of our products, and expanding the evidence of the cost effectiveness of our technologies.

As of December 31, 2013, the Company's cash balance was $1,267,000. The Company incurred net losses of $2,419,000 for the six-month period ended December 31, 2013 and $4,292,000 and $4,695,000 in the fiscal years ended June 30, 2013 and 2012, respectively. In addition, the Company has accumulated aggregate net losses from the inception of business through December 31, 2013 of $121,437,000.

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. On June 28, 2013, we entered into a Restructuring Agreement with Medtronic related to the $7.5 million 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 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 accrues at a rate of 6 percent, compounded annually and is payable in five equal installments of principal plus accrued interest on March 31st of 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 in fiscal year 2013.

Under the license agreement, royalty payments for Prostiva products are paid one year in arrears based on the contract year. The royalty payment due during the second quarter of fiscal year 2014 of $650,000 has not been paid as of December 31, 2013 or as of the date of filing this Quarterly Report on Form 10-Q. The $650,000 is included in the short-term deferred acquisition payment liability as of December 31, 2013. In addition, we did not pay, as of December 31, 2013 and as of the date of filing this Quarterly Report on Form 10-Q, the annual $65,000 licensing maintenance fee due on October 6, 2013 which is included in other accrued expenses as of December 31, 2013. The non-payment does not entitle Medtronic to terminate the license agreement unless Medtronic provides written notice and an opportunity to cure the default. The non-payment under the license agreement is also not an event of default under the Note unless Medtronic provides written notice and 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 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 fund our anticipated capital needs, operating expenses (including payments under the license agreement), and Note repayments, 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. Our ability to continue as a going concern is dependent upon improving our liquidity.


The Company is considering all available alternatives to improve its cash and liquidity position. In particular, the Company is attempting to generate revenues both from sales of our Cooled ThermoTherapy and Prostiva products in an amount sufficient to improve cash flow from our business. The Company also implemented a restructuring plan early in the third quarter of fiscal year 2014 to reduce our cash utilization (see Footnote 15 for further details). 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.

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, 2013. At December 31, 2013, our critical accounting policies and estimates continue to include revenue recognition, inventories, valuation of long-lived assets and goodwill, income taxes, stock-based compensation and fair value of contingent consideration.

RESULTS OF OPERATIONS

Net Sales
Net sales for the three-months ended December 31, 2013 were $3.8 million, compared to $4.4 million during the same period of the prior fiscal year. The $548,000, or 13 percent decrease in net sales for the comparable prior year period is primarily the result of lower volume of units sold in both Cooled ThermoTherapy and Prostiva RF Therapy product lines.

Net sales for the six-months ended December 31, 2013 were $7.6 million, compared to $8.3 million for the six-months ended December 31, 2012. The decrease in net sales of $739,000, or 9 percent, is again a result of decrease in units sold in both product lines, Cooled ThermoTherapy and Prostiva RF Therapy.

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 December 31, 2013 decreased $109,000, or 5 percent, to $2.0 million, from $2.1 million for the three-month period ended December 31, 2012. Costs of goods sold of $3.9 million for the six-month period ended December 31, 2013 decreased by $149,000 or 4 percent compared with the $4.1 million reported for the six-month period ended December 31, 2012. The decrease in costs of goods sold for the three and six-months ended December 31, 2013 is a result of the decrease in sales, partially offset by higher per unit manufacturing costs due to lower production volumes resulting in higher fixed costs per unit, as well as higher material costs.

Gross profit as a percentage of net sales decreased to 47 and 48 percent, respectively, for the three and six-month periods ended December 31, 2013 from 51 percent for the three and six-month periods ended December 31, 2012, respectively. The decrease in the gross margin rate for the three and six-month periods ended December 31, 2013 is due to the higher manufacturing costs per unit noted above.

Sales and Marketing
Sales and marketing expense of $1.7 million for the second quarter of fiscal year 2014 decreased by $326,000, or 16 percent, when compared to sales and marketing expense of $2.0 million in the same period of fiscal 2013. The decrease in sales and marketing expense for the three-months ended December 31, 2013 is due to a $164,000 decrease in headcount related expenses mainly due to decreased commissions, a $100,000 decrease in travel related expenses and meeting expenses, as well as a $48,000 decrease in marketing expenses.

Sales and marketing expense of $3.5 million for the six-month period ended December 31, 2013 decreased $197,000, or 5 percent, when compared to sales and marketing expense of $3.7 million in the same period of fiscal 2013. The decrease in sales and marketing expense year-over-year is largely due to decreased travel related expenses and meeting expenses of $134,000, as well as a decrease in marketing expenses of $131,000, partially offset by a $77,000 increase in headcount related expenses.


General and Administrative
General and administrative expense decreased $85,000, or 13 percent, to $561,000 for the three-month period ended December 31, 2013 compared to $646,000 for the three-month period ended December 31, 2012. The decrease in general and administrative expense is a result of a decrease in wages and benefits due to lower headcount.

For the six-months ended December 31, 2013, general and administrative expense decreased $137,000 or 10 percent to $1.2 million from $1.4 million for the six-month period ended December 31, 2012. The decrease in general and administrative expense is again a result of a decrease in wages and benefits of $210,000 due to lower headcount, partially offset by an increase in consulting fees of $71,000.

Research and Development
Research and development expense, which includes expenditures for product development, regulatory compliance and clinical studies, decreased $150,000 or 25 percent to $452,000 from $602,000 for the three-month period ended December 31, 2013. The decrease in research and development expense is a result of a $90,000 decrease in expense for the monthly transition services fee related to the Prostiva license agreement which was paid in the prior year period. These fees ended when we became the legal manufacturer of Prostiva in April 2013. The remaining decrease is related to decreases in consulting services which did not repeat in fiscal year 2014.

For the six-months ended December 31, 2013, research and development expense decreased $344,000 or 28 percent to $874,000 from $1.2 million for the six-month period ended December 31, 2012. The decrease in research and development expense year-over-year is a result of a $180,000 decrease in expense for the monthly transition services fee related to the Prostiva license agreement mentioned above, as well as decreases in consulting expenses.

Change in Value of Acquisition Consideration The change in the value of acquisition consideration was $85,000 and $93,000, respectively, for the three and six-month periods ended December 31, 2013, compared to $215,000 and $369,000 for the three and six- month periods ended December 31, 2012, respectively. For the three and six-month periods ended December 31, 2013, the change in the value of acquisition consideration represents the reduction in fair value of contingent consideration of $85,000 and $93,000, respectively, as a result of a reduction in the projected royalty payments in excess of contractual minimums in earlier years. For the three-month period ended December 31, 2012, the change in the value of acquisition consideration represents the net effect of a reduction in fair value of contingent consideration of $411,000, partially offset by an increase of $196,000 in non-contingent consideration. For the six-month period ended December 31, 2012, 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.

Medical Device Tax
The medical device excise tax expense of $59,000 and $119,000, for the three and six-month periods ended December 31, 2013, respectively, 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 $22,000 and $26,000 for the three-month period ended December 31, 2013 and 2012, respectively. Amortization of identifiable intangible assets was $44,000 and $52,000 for the six-month period ended December 31, 2013 and 2012, respectively. The slight decrease in the amortization expense is a result of the $160,000 impairment charge related to intangible assets acquired as part of the Prostiva acquisition in the fourth quarter of fiscal 2013 which resulted in lower amortization expense over the assets remaining useful lives.

Net Interest Expense
Interest expense is a result of non-cash interest accretion on the deferred acquisition payments for the Prostiva business as well as the interest expense accrued on the Note entered into with Medtronic on June 28, 2013. Interest expense increased to $178,000 from $127,000 for the three-months ended December 31, 2013 and 2012, respectively. For the six-months ended December 31, 2013, interest expense increased $89,000 to $338,000 from $249,000 for the six-months ended December 31, 2012. The increase in interest expense is due to accrued interest on the Medtronic Note agreement signed at the end of fiscal year 2013, partially offset by lower accretion expense related to the restructuring of the license agreement with Medtronic which resulted in the re-measurement of the contingent consideration.


Provision for Income Taxes
We recognized income tax expense of $16,000 and $28,000 for the three and six-months ended December 31, 2013, respectively, compared to income tax expense of $16,000 and $32,000 for the three and six-month periods ended December 31, 2012, respectively. The tax expense in the three and six-months ended December 31, 2013 consists of $11,000 and $18,000, respectively, of deferred tax expense recorded on the amortization for tax purposes of indefinite-lived goodwill . . .
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