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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005

 

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transaction period from              to             

 

Commission File Number 0-28414

 


 

UROLOGIX, INC.

(Exact name of registrant as specified in its charter)

 


 

Minnesota   41-1697237

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

14405 21st Avenue North, Minneapolis, MN 55447

(Address of principal executive offices)

 

Registrant’s telephone number, including area code: (763) 475-1400

 


 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2) of the Exchange Act.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

As of May 1, 2005, the Company had outstanding 14,305,004 shares of common stock, $.01 par value.

 



PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

 

Urologix, Inc.

Condensed Balance Sheets

(In thousands, except per share data)

 

     March 31,
2005


   

June 30,

2004


 
     (unaudited)     (*)  
ASSETS                 
Current assets:                 

Cash and cash equivalents

   $ 9,411     $ 5,142  

Available-for-sale investments

     773       2,462  

Accounts receivable, net of allowances of $326 and $299

     3,299       2,689  

Inventories

     2,125       2,144  

Prepaids and other current assets

     176       371  
    


 


Total current assets

     15,784       12,808  
    


 


Property and equipment:                 

Machinery, equipment and furniture

     9,774       9,256  

Less accumulated depreciation

     (7,315 )     (6,583 )
    


 


Property and equipment, net

     2,459       2,673  

Other assets

     1,771       2,049  

Goodwill, net

     10,193       10,193  

Other intangible assets, net

     7,951       8,449  
    


 


Total assets

   $ 38,158     $ 36,172  
    


 


LIABILITIES AND SHAREHOLDERS’ EQUITY                 
Current liabilities:                 

Accounts payable

   $ 1,311     $ 949  

Accrued compensation

     786       1,425  

Other accrued expenses

     1,338       1,532  

Note payable

     —         165  

Deferred income

     1,238       1,383  
    


 


Total current liabilities

     4,673       5,454  
    


 


COMMITMENTS AND CONTINGENCIES (Note 11)

                
Shareholders’ equity:                 

Common stock, $.01 par value, 25,000 shares authorized; 14,305 and 14,194 shares issued and outstanding

     143       142  

Additional paid-in capital

     110,094       109,653  

Accumulated deficit

     (76,751 )     (79,086 )

Accumulated other comprehensive (loss) income

     (1 )     9  
    


 


Total shareholders’ equity

     33,485       30,718  
    


 


Total liabilities and shareholders’ equity

   $ 38,158     $ 36,172  
    


 



(*) The Balance Sheet at June 30, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

The accompanying notes to financial statements are an integral part of these statements.


Urologix, Inc.

Condensed Statements of Operations

(In thousands, except per share data)

(Unaudited)

 

     Three Months Ended
March 31,


   Nine Months Ended
March 31,


 
     2005

   2004

   2005

   2004

 
Sales    $ 6,524    $ 6,668    $ 18,925    $ 17,348  
Cost of goods sold      2,002      2,491      5,751      6,787  
    

  

  

  


Gross profit      4,522      4,177      13,174      10,561  
    

  

  

  


Costs and expenses:                              

Selling, general and administrative

     2,926      3,096      8,454      9,068  

Research and development

     795      559      2,230      1,774  

Amortization of intangible assets

     41      41      123      123  

Restructuring

     —        —        —        (175 )
    

  

  

  


Total costs and expenses      3,762      3,696      10,807      10,790  
    

  

  

  


Operating earnings (loss)      760      481      2,367      (229 )
Interest income, net      34      21      91      34  
    

  

  

  


Net earnings (loss) before taxes      794      502      2,458      (195 )
Provision for income taxes      40      —        123      —    
    

  

  

  


Net earnings (loss)    $ 754    $ 502    $ 2,335    $ (195 )
    

  

  

  


Net earnings (loss) per common share - basic    $ 0.05    $ 0.04    $ 0.16    $ (0.01 )
    

  

  

  


Net earnings (loss) per common share - diluted    $ 0.05    $ 0.03    $ 0.16    $ (0.01 )
    

  

  

  


Weighted average number of shares used in basic per share calculations      14,304      14,015      14,270      13,989  
    

  

  

  


Weighted average number of shares used in diluted per share calculations      14,606      14,769      14,834      13,989  
    

  

  

  


 

The accompanying notes to financial statements are an integral part of these statements.


Urologix, Inc.

Condensed Statements of Cash Flows

(In thousands)

(Unaudited)

 

     Nine Months Ended
March 31,


 
     2005

    2004

 
Operating Activities:                 

Net earnings (loss)

   $ 2,335     $ (195 )

Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:

                

Depreciation and amortization

     1,422       1,527  

Provision for bad debts

     58       17  

Change in operating items:

                

Accounts receivable

     (668 )     (54 )

Inventories

     (599 )     594  

Prepaids and other assets

     473       600  

Accounts payable

     362       (512 )

Accrued expenses and deferred income

     (1,039 )     (462 )
    


 


Net cash provided by operating activities

     2,344       1,515  
    


 


Investing Activities:                 

Purchase of property and equipment

     (92 )     (24 )

Proceeds from sale / maturity of available-for-sale investments, net

     1,679       1,029  
    


 


Net cash provided by investing activities

     1,587       1,005  
    


 


Financing Activities:                 

Payments made on capital lease obligations

     —         (351 )

Payments made on note payable

     (104 )     (410 )

Proceeds from exercise of stock options

     442       262  
    


 


Net cash provided by ( used for) financing activities

     338       (499 )
    


 


Net increase in cash and cash equivalents      4,269       2,021  
Cash and cash equivalents:                 

Beginning of period

     5,142       727  
    


 


End of period

   $ 9,411     $ 2,748  
    


 


Supplemental cash-flow information                 

Cash paid during the period for interest

   $ 16     $ 157  

Net value of inventory transferred to / (from) property and equipment

   $ 618     $ (101 )

 

The accompanying notes to financial statements are an integral part of these statements.


Urologix, Inc.

Notes to Condensed Financial Statements

March 31, 2005

(Unaudited)

 

1. Basis of presentation

 

The accompanying unaudited condensed financial statements of Urologix, Inc. (the “Company” or “Urologix”) have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Article 10 of Regulation S-X. The balance sheet as of March 31, 2005, and the statements of operations for the three and nine month periods ended March 31, 2005 and 2004 and statements of cash flows for the nine month periods ended March 31, 2005 and 2004 are unaudited but include all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the financial position at such date and the operating results and cash flows for those periods. Certain information normally included in financial statements and related footnotes prepared in accordance with U.S. generally accepted accounting principles has been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The accompanying financial statements should be read in conjunction with the financial statements and notes included in Urologix’ Annual Report on Form 10-K for the year ended June 30, 2004.

 

Results for any interim period shown in this report are not necessarily indicative of results to be expected for any other interim period or for the entire year. Certain prior year amounts have been reclassified to conform to current year presentation.

 

2. New Accounting Pronouncements

 

In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 151 “Inventory Costs, an amendment of ARB No. 43, Chapter 4,” which clarifies the types of costs that should be expensed rather than capitalized as inventory. This statement also clarifies the circumstances under which fixed overhead costs associated with operating facilities involved in inventory processing should be capitalized. The provisions of SFAS No. 151 are effective for fiscal years beginning after June 15, 2005 and we will adopt this standard on July 1, 2005. No material impact on our financial statements is expected from the adoption of this standard.

 

In December 2004, the FASB issued SFAS No. 123 (Revised 2004), “Share-Based Payment.” SFAS No. 123R is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. SFAS No. 123R focuses primarily on accounting for transactions in which an entity obtains employee services through share-based payment transactions. SFAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award at the date of grant. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award. SFAS No. 123R is effective as of the beginning of the first annual reporting period that begins after June 15, 2005 and we will adopt this standard on July 1, 2005. While we cannot precisely determine the impact on net earnings as a result of the adoption of SFAS No. 123R, estimated compensation expense related to prior periods can be found in Note 5 in the Notes to Condensed Financial Statements included in this Form 10-Q and in the Financial Statements included in our Form 10-K for the fiscal year ended June 30, 2004. The ultimate amount of increased compensation expense will be dependent on a number of factors including whether we adopt SFAS 123R using the modified prospective or retrospective method, the number of option shares granted during the year, their timing and vesting period, and the method used to calculate the fair value of the awards.


Urologix, Inc.

Notes to Condensed Financial Statements

March 31, 2005

(Unaudited)

 

3. Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

 

4. Basic and diluted earnings (loss) per share

 

Basic earnings (loss) per share was computed by dividing the net earnings (loss) by the weighted average number of shares of common stock outstanding during the periods presented. Diluted earnings per share was computed by dividing the net earnings by the weighted average number of shares of common stock outstanding plus all dilutive potential common shares that result from stock options. The number of shares used in earnings per share computations are as follows (in thousands):

 

     Three months ended
March 31,


   Nine months ended
March 31,


     2005

   2004

   2005

   2004

Weighted average common shares outstanding - basic

   14,304    14,015    14,270    13,989

Dilutive effect of stock options

   302    754    564    —  
    
  
  
  

Weighted average common shares outstanding - diluted

   14,606    14,769    14,834    13,989
    
  
  
  

 

The dilutive effect of stock options in the above table excludes 598,000, 431,000, and 270,000 of options, respectively, for which the exercise price was higher than the average closing price for the three and nine month periods ended March 31, 2005 and the three month period ended March 31, 2004.

 

As a result of the net loss for the nine month period ended March 31, 2004, dilutive potential common shares from stock options of 460,000 were excluded from the calculation of diluted earnings per share as the effect would be antidilutive.


Urologix, Inc.

Notes to Condensed Financial Statements

March 31, 2005

(Unaudited)

 

5. Stock-Based Compensation

 

We account for stock-based employee compensation arrangements in accordance with the provisions and related interpretations of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and have elected to follow the “disclosure only” alternative prescribed by SFAS No. 123, “Accounting for Stock-Based Compensation”.

 

Had compensation cost for stock-based compensation been determined consistent with SFAS No. 123, the net earnings (loss) and net earnings (loss) per share would have been adjusted to the following pro-forma amounts (in thousands, except for per share data):

 

     Three months ended
March 31,


    Nine months ended
March 31,


 
     2005

    2004

    2005

    2004

 

Net earnings (loss), as reported

   $ 754     $ 502     $ 2,335     $ (195 )

Total stock-based employee compensation expense determined under fair value based method, net of tax

     (725 )     (652 )     (1,966 )     (1,945 )
    


 


 


 


Pro forma net earnings (loss)

   $ 29     $ (150 )   $ 369     $ (2,140 )
    


 


 


 


Net earnings (loss) per share:

                                

Basic - as reported

   $ 0.05     $ 0.04     $ 0.16     $ (0.01 )

Basic - pro forma

   $ —       $ (0.01 )   $ 0.03     $ (0.15 )

Diluted - as reported

   $ 0.05     $ 0.03     $ 0.16     $ (0.01 )

Diluted - pro forma

   $ —       $ (0.01 )   $ 0.02     $ (0.15 )

 

6. Inventories

 

Inventories consisted of the following as of (in thousands):

 

     March 31,
2005


   June 30,
2004


Raw materials

   $ 1,338    $ 1,304

Work in process

     242      163

Finished goods

     545      677
    

  

Total inventories

   $ 2,125    $ 2,144
    

  

 

 

 


Urologix, Inc.

Notes to Condensed Financial Statements

March 31, 2005

(Unaudited)

 

7. Other intangible assets, net

 

Other intangible assets consist of developed technologies, customer base and trademarks. Developed technologies and customer base are amortized using the straight-line method over their estimated useful lives of 15 and 14 years, respectively. The trademark asset is considered to be an intangible with an indefinite useful life, and it will not be amortized unless it is determined that the useful life is no longer indefinite.

 

Effective July 1, 2004, we began including amortization expense relating to developed technologies within cost of goods sold. This expense was previously reported within amortization of intangible assets on the statements of operations. Consistent with this change, we have re-classified $125,000 and $375,000 of such expense to cost of goods sold for the three and nine month periods ended March 31, 2004, respectively. Amortization expense related to other intangible assets was $166,000 and $498,000 respectively, for the three and nine month periods ended March 31, 2005, of which, $125,000 and $375,000, respectively, was reported in cost of goods sold. Amortization expense for the final three months of fiscal 2005 and for each of the next four fiscal years is expected to be $166,000 and $664,000, respectively.

 

Balances of other intangible assets, net, were as follows (in thousands):

 

     As of March 31, 2005

     Carrying
Amount


   Accumulated
Amortization


   Net

Amortizing intangibles:

                    

Developed technologies

   $ 7,500    $ 2,250    $ 5,250

Customer base

     2,300      739      1,561
    

  

  

Subtotal

     9,800      2,989      6,811
    

  

  

Non-amortizing intangibles:

                    

Trademarks

                   1,140
                  

Total other intangible assets

                 $ 7,951
                  

 

 


Urologix, Inc.

Notes to Condensed Financial Statements

March 31, 2005

(Unaudited)

 

8. Comprehensive income (loss)

 

Comprehensive income (loss) includes all changes in equity during a period except those resulting from investments by and distributions to shareholders. Our comprehensive income (loss) is as follows (in thousands):

 

     Three months ended
March 31,


    Nine months ended
March 31,


 
     2005

   2004

    2005

    2004

 

Net earnings (loss)

   $ 754    $ 502     $ 2,335     $ (195 )

Change in net unrealized gains (losses) on available-for-sale investments

     —        (10 )     (10 )     (56 )
    

  


 


 


Comprehensive income (loss)

   $ 754    $ 492     $ 2,325     $ (251 )
    

  


 


 


 

9. Warranty

 

Some of our products are covered by warranties against defects in material and workmanship for periods of up to twenty-four months. We record a liability for warranty claims at the time of sale. The amount of the liability is based on the trend in the historical ratio of product failure rates, material usage and service delivery costs, the historical length of time between the sale and resulting warranty claim and other factors.

 

Warranty provisions and claims for the nine month periods ended March 31, 2005 and 2004 were as follows (in thousands):

 

Fiscal Year      


  

Beginning

Balance

at July 1


  

Warranty

Provisions


  

Warranty

Claims


   

Ending

Balance

at March 31


2005

   $ 215    $ 238    $ (310 )   $ 143

2004

   $ 159    $ 203    $ (127 )   $ 235


Urologix, Inc.

Notes to Condensed Financial Statements

March 31, 2005

(Unaudited)

 

10. Restructuring Liability

 

In May 2003, we announced plans for an organizational restructuring which eliminated 28 positions within the Company and also resulted in our vacating a portion of our leased facility. All of the targeted headcount reductions were completed by June 2003, and we reached an agreement to sublet the vacated space beginning in the second quarter of fiscal 2004. All of the severance obligations were paid in fiscal 2004. The lease term on the vacated space currently runs through fiscal 2008.

 

Restructuring activity for the nine month periods ended March 31, 2005 and 2004 were as follows (in thousands):

 

     Fiscal 2005

    Fiscal 2004

 
     Severance

   Lease

    Total

    Severance

    Lease

    Total

 

Beginning balance at July 1

   $ —      $ 169     $ 169     $ 636     $ 264     $ 900  

Expense accurals (reversals)

     —        —         —         (185 )     10       (175 )

Cash payments

     —        (33 )     (33 )     (426 )     (94 )     (520 )
    

  


 


 


 


 


Ending balance at March 31

   $ —      $ 136     $ 136     $ 25     $ 180     $ 205  
    

  


 


 


 


 


 

11. Legal Proceedings

 

Our business exposes us to product liability claims that are inherent in the testing, production, marketing and sale of medical devices. As a consequence, we are involved in various legal actions in the ordinary course of our business. Although the outcome of any such legal actions cannot be predicted, management believes any losses that may occur from these matters are adequately covered by insurance, subject to applicable deductibles, and that there is no pending legal proceeding against or involving the Company for which the outcome is likely to have a material adverse effect upon the Company’s statement of financial position or results of operations.


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

 

The following is a discussion and analysis of Urologix’ financial condition as of March 31, 2005 and results of operations for the three and nine month periods ended March 31, 2005 and 2004. 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, 2004.

 

Cautionary Note Regarding Forward-Looking Statements

 

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, including the need to maintain profitability and increase revenues; the rate of adoption of Cooled ThermoTherapy products, Urologix’ sole products, by the medical community; the impact of competitive treatments, products and pricing; the development and effectiveness of the Company’s sales organization and marketing efforts; developments in the reimbursement environment for the Company’s products including the determination of reimbursement rates for Cooled ThermoTherapy (transurethral microwave thermotherapy); the ability of third-party suppliers to produce and supply products; the risk of product liability claims and the adequacy of our product liability insurance coverage; the Company’s ability to successfully defend its intellectual property against infringement and the cost and expense associated with that effort. We caution readers not to place undue reliance on any of these forward-looking statements, which speak only as of the date made. A detailed discussion of risks and uncertainties may be found below in “Factors That May Affect Our Future Results and The Trading Price of Our Common Stock” and in our Annual Report on Form 10-K for the year ended June 30, 2004.

 

OVERVIEW

 

Urologix, Inc., based in Minneapolis, Minnesota develops, manufactures and markets minimally invasive medical products for the treatment of urological disorders.

 

We have developed and offer non-surgical, catheter-based therapies that use a proprietary cooled microwave technology for the treatment of benign prostatic hyperplasia (BPH), a disease that dramatically affects more than 23 million men worldwide by causing adverse changes in urinary voiding patterns. We market our products under the Targis® and Prostatron® names. Both systems utilize Cooled ThermoTherapy, a targeted microwave energy combined with a unique cooling mechanism that protects healthy tissue and enhances patient comfort while providing safe, effective, lasting relief from the symptoms of BPH. Cooled ThermoTherapy can be performed without anesthesia or intravenous sedation and, as a result, can be performed in a physician’s office or an outpatient clinic. We believe Cooled ThermoTherapy provides an efficacious, safe and cost-effective solution for BPH that is superior to medication without the complications and side effects inherent in more invasive surgical procedures.

 

We believe that third-party reimbursement is essential to the acceptance of Cooled ThermoTherapy, and that clinical efficacy, overall cost effectiveness and physician advocacy will be keys to obtaining this reimbursement. We estimate that 60% to 80% of patients who receive Cooled ThermoTherapy treatment in the United States will be eligible for Medicare coverage. The remaining patients will either be covered by private insurers, including traditional indemnity health insurers and managed care organizations, or they will be private-paying patients. As a result, Medicare reimbursement is particularly critical for widespread market acceptance of Cooled ThermoTherapy in the United States.

 

The level of Medicare reimbursement for Cooled ThermoTherapy is dependent on the site of service. Beginning on August 1, 2000, the Centers for Medicare and Medicaid Services (CMS) replaced the reasonable cost basis of reimbursement for outpatient hospital-based procedures, including Cooled ThermoTherapy, with a new fixed rate or prospective payment system. Under this method of reimbursement, a hospital receives a fixed reimbursement for each Cooled ThermoTherapy treatment performed in its facility, approximately $2,100 in calendar year 2005, although the rate varies depending on a wage index and other factors for each hospital. The urologist performing the Cooled ThermoTherapy treatment receives reimbursement of approximately $500 per procedure. The reimbursement rates for calendar 2005 are consistent with the 2004 rates.


In January 2001, CMS began to reimburse for Cooled ThermoTherapy treatments performed in the urologist’s office. The reimbursement rate (inclusive of the physician’s fee) in calendar year 2005 for Cooled ThermoTherapy procedures performed in the urologist’s office is approximately $3,900, compared to $4,000 in calendar 2004, which is subject to geographic adjustment.

 

In July 2003, CMS added the CPT Code covering Cooled ThermoTherapy to the ASC list of Medicare approved procedures providing a reimbursement rate for ambulatory surgical centers (ASC). Procedures in an ASC are reimbursed under a two part system similar to hospital reimbursement. The ASC receives a fixed reimbursement for each Cooled ThermoTherapy procedure performed. Cooled ThermoTherapy is in ASC payment group 9 which reimburses approximately $1,300, the highest amount allowed under this system. The urologist performing the procedure is reimbursed the same amount as if the treatment occurred in a hospital, approximately $500. This low facility reimbursement rate relative to the cost of the procedure potentially limits the number of Cooled ThermoTherapy treatments done in an ASC.

 

Private insurance companies and HMO’s make their own determinations regarding coverage and reimbursement based upon “usual and customary” fees. To date, we have received coverage and reimbursement in various geographies from private insurance companies and HMOs throughout the United States. We intend to continue our efforts to gain coverage and reimbursement across the United States. There can be no assurance that we will receive favorable coverage or reimbursement determinations for Cooled ThermoTherapy from these payers or that amounts reimbursed to physicians for performing Cooled ThermoTherapy procedures will be sufficient to encourage physicians to use Cooled ThermoTherapy. Internationally, reimbursement approvals for the Cooled ThermoTherapy procedure are awarded on an individual-country basis.

 

Our goal is to grow Cooled ThermoTherapy as a standard of care for the treatment of BPH. The key aspects of our business strategy to achieve this goal are to (i) increase the use of Cooled ThermoTherapy by physicians who already have access to a Cooled ThermoTherapy system, (ii) satisfy additional demand for Cooled ThermoTherapy systems through the efficient use of our installed base of Cooled ThermoTherapy system control units, and (iii) increase market awareness of Cooled ThermoTherapy.

 

Our revenues are primarily generated through the sale of our disposable treatment catheters, and to a lesser extent, sales of our Cooled ThermoTherapy system control units. We believe that continued growth in revenue from the sale of our disposable treatment catheters will be key to maintaining profitability and positive cash flow.

 

We will continue to invest and focus our resources on growing our revenues, developing new products that expand our product platform, and continuing clinical trials in support of regulatory and reimbursement approvals. Our ability to maintain profitability in the future will be dependent upon, among other factors, our success in achieving increased treatment volume and market acceptance of the Cooled ThermoTherapy procedures in the physician’s office, our success in obtaining and maintaining necessary regulatory clearances, our ability to manufacture at the volumes and quantities the market requires, the extent to which Medicare and other health care payers continue to reimburse costs of Cooled ThermoTherapy procedures performed in hospitals, ambulatory surgery centers and physicians’ offices and the amount of reimbursement provided.

 

We anticipate fiscal 2005 annual revenues in the range of $25.5 million to $26.2 million, compared to $24.3 million in fiscal year 2004. Diluted net earnings per share are expected to be $0.20 to $0.22 per share compared to $0.04 per share last fiscal year.


Critical Accounting Policies:

 

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 statements, financial results and condition, and require complex management judgment.

 

Revenue Recognition

 

We recognize revenue from the sale of Cooled ThermoTherapy system control units upon delivery to the customer. We recognize revenue from treatment catheter sales at the time of shipment. In addition to our sales of Cooled ThermoTherapy system control units, we place our Cooled ThermoTherapy system control units with customers under a variety of programs for both evaluation and long-term use. We retain title to these control units and do not recognize any revenue on these control units until title has transferred. These programs are designed to expand access to our technology, and thus expand the market for our single-use treatment catheters. Under these programs, we generally charge a higher price for each single-use treatment catheter to include the use of our Cooled ThermoTherapy system control unit by the customer. We recognize revenue on these single-use treatment catheters at the time of shipment. Revenue for warranty service contracts is deferred and recognized over the contract period. 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 other known factors. If the historical data used to calculate these estimates does not properly reflect future returns, our revenues could be overstated.

 

Allowance for Doubtful Accounts

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. This allowance is a significant estimate and is regularly evaluated by us for adequacy by taking into consideration factors such as past experience, credit quality of the customer base, age of the receivable balances, both individually and in the aggregate, and current economic conditions that may affect a customer’s ability to pay. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

 

Product Warranty

 

We record a liability for warranty claims at the time of sale. The amount of the liability is based on the trend in the historical ratio of product failure rates, material usage and service delivery costs, the historical length of time between the sale and resulting warranty claim and other factors. Should actual product failure rates, material usage or repair costs differ from our estimates, revisions to the estimated warranty liability would be required.

 

Inventories and Related Allowance for Excess and Obsolete Inventory

 

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 the first-in, first-out (“FIFO”) basis. The inventory cost includes both merchandise and freight. A quarterly 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.

 

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 and Intangible Assets and Goodwill

 

In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets,” we have ceased to amortize approximately $10.2 million of goodwill and $1.1 million of trademarks. Goodwill and trademarks are tested for impairment annually or more frequently if changes in circumstance or the occurrence of events suggests an impairment exists. The test for impairment requires us to make several estimates about fair value, most of which are based on projected future cash flows. Our estimates associated with the impairment tests are considered critical, due to the amount of goodwill and trademarks recorded on our balance sheet and the judgment required in determining fair value amounts, including projected future cash flows.

 

Other intangible assets consist of developed technologies, customer base and trademarks. Developed technologies and customer base are amortized using the straight-line method over their estimated useful lives of 15 and 14 years, respectively. The trademark asset is considered to be an intangible asset with an indefinite useful life, and it will not be amortized until its useful life is determined to be no longer indefinite. We review the definite lived intangible assets for impairment as changes in circumstance or the occurrence of events suggests the remaining value is not recoverable.

 

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 bases of assets and liabilities. We regularly assess the likelihood that our deferred tax assets will be recovered from future taxable income. We have recorded and continue to carry a full valuation allowance against our net deferred tax assets. We consider projected future taxable income and ongoing tax planning strategies in assessing the amount of the valuation allowance. If we determine it is more likely than not that we will realize all or part of our deferred tax assets, we will adjust our earnings for the deferred tax in the period we make the determination. With our last five quarters of profit and in light of our historical losses, we continue to assess the need for a full valuation allowance against our net deferred tax assets. The valuation allowance at June 30, 2004 was $31.7 million. 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.


RESULTS OF OPERATIONS

 

Net Sales

 

Net sales for the three month period ended March 31, 2005 decreased to $6.5 million from $6.7 million in the prior year period. The decrease in revenue during the period was primarily due to a decrease in the number of Cooled ThermoTherapy system control units sold during the quarter, partially offset by an increase in revenue from the sale of single-use treatment catheters. Net sales for the nine-month period ended March 31, 2005 increased to $18.9 million from $17.3 million in the same period of fiscal 2004. The sales growth resulted primarily from increased revenues from the sale of our single-use treatment catheters in the United States partially offset by a decrease in the number of Cooled ThermoTherapy system control units sold during the period as well as lower revenues from the sale of our single-use treatment catheters internationally. Average per unit selling prices of our single-use treatment catheters increased in both the three and nine month periods ended March 31, 2005 compared to the same periods in the prior year, due primarily to our price standardization initiative that was implemented effective January 1, 2004, as well as a stronger mix of sales to our direct office accounts. Sales of our single-use treatment catheters accounted for approximately 94% of our revenue in the three month period ended March 31, 2005 compared to approximately 91% of revenue in the same period of the prior year. For the first nine months of fiscal 2005, sales of single-use treatment catheters accounted for approximately 94% of revenue compared to 92% of revenue in the first nine months of fiscal 2004.

 

At March 31, 2005, we had a domestic installed base of 481 Cooled ThermoTherapy systems, including the units that are being used by customers pursuant to our evaluation and long-term use programs. This compares to an installed base of 453 units at December 31, 2004 and 427 units at June 30, 2004.

 

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, and amortization expense relating to developed technologies. Effective July 1, 2004, we began including amortization expense related to developed technologies within cost of goods sold. This expense was previously reported within amortization of intangibles and consistent with this change, we have re-classified this expense to cost of goods sold for the periods prior to July 1, 2004. For the three and nine month periods ended March 31, 2004, the re-classification adjustment was $125,000 and $375,000, respectively.

 

Cost of goods sold for the three month period ended March 31, 2005 decreased to $2.0 million from $2.5 million during the same period of the prior fiscal year. The decrease in cost of goods sold resulted primarily from a decrease in the number Cooled ThermoTherapy system control units sold during the period combined with lower per unit manufacturing costs of our single-use treatment catheters. Cost of goods sold for the nine month period ended March 31, 2005 decreased to $5.8 million from $6.8 million in the same period last fiscal year. The decrease resulted primarily from a decrease in the number of Cooled ThermoTherapy system control units sold during the period combined with lower per unit manufacturing costs of our single-use treatment catheters as well as the $160,000 charge that occurred in the first quarter of fiscal 2004 for a commitment to purchase additional control unit inventory at prices which exceeded the expected future sales value.

 

Gross profit as a percentage of sales for the three and nine month periods ended March 31, 2005 increased to 69% and 70%, respectively, from 63% and 61%, respectively, in the three and nine month periods ended March 31, 2004. The increase in gross profit rates in both periods resulted primarily from an increased percentage of treatment catheter revenue in both periods of fiscal 2005 combined with increased average per unit selling prices of our single-use treatment catheters and reductions in their per unit manufacturing cost.

 

Selling, General & Administrative

 

Selling, general and administrative expenses decreased to $2.9 million and $8.5 million, respectively, for the three and nine month periods ended March 31, 2005 from $3.1 million and $9.1 million, respectively, in the same periods of fiscal year 2004. The decrease in expenses for the third quarter of fiscal 2005 resulted primarily from a reduction in corporate overhead expenses, partially offset by an increase in expenses related to Sarbanes-Oxley Section 404 compliance efforts. The decrease in expenses for the first nine months of fiscal 2005 resulted primarily from a reduction in legal expenses related to the patent infringement suit we filed to protect our intellectual property which was settled in January 2004 and a reduction in corporate overhead expenses, partially offset by an increase in expenses related to Sarbanes-Oxley Section 404 compliance.


Research and Development

 

Research and development expenses, which include expenditures for product development, regulatory compliance and clinical studies, increased to $795,000 and $2.2 million, respectively, for the three and nine month periods ended March 31, 2005, from $559,000 and $1.8 million in the same periods of fiscal 2004. The increase in expenses in both periods resulted primarily from increased expenditures on product development activities partially offset by lower clinical trial expenses.

 

Amortization of Intangible Assets

 

As noted above, effective July 1, 2004, we began including amortization expense relating to developed technologies within cost of goods sold. This expense was previously reported within amortization of intangible assets. Consistent with this change, we have re-classified this expense from amortization of intangible assets to cost of goods sold for the periods prior to this change. For the three and nine month periods ended March 31, 2004, the re-classification adjustment was $125,000 and $375,000, respectively.

 

Amortization of intangible assets was $41,000 and $123,000 for both of the three and nine month periods ended March 31, 2005 and 2004, respectively. This amortization expense is related to the acquired customer base that resulted from the purchase of the Prostatron Cooled ThermoTherapy product line from EDAP in October 2000.

 

Restructuring

 

In May 2003, we announced plans for organizational restructuring which eliminated 28 positions within the Company and also resulted in our vacating a portion of our leased facility. During the fourth quarter of fiscal 2003, we recorded a $1.3 million restructuring charge to cover the expenses associated with these items. All of the targeted headcount reductions were completed by June 2003, and we began to sublet the vacated space in the second quarter of fiscal 2004.

 

The $175,000 restructuring benefit for the nine month period ended March 31, 2004, resulted from a reduction in our severance obligations related to the May 2003 workforce reduction.

 

Net Interest Income

 

Net interest income for the three and nine month periods ended March 31, 2005 increased to $34,000 and $91,000, respectively, from $21,000 and $34,000, respectively, in the same periods of fiscal 2004. The increase in both periods is due to higher cash and investment balances as well as a reduction in interest expense associated with the lease obligation assumed as part of the Prostatron acquisition in October 2000. The lease obligation was completed during the third fiscal quarter of 2004.

 

Provision for Income Taxes

 

Income tax expense increased to $40,000 and $123,000, respectively, for the three and nine month periods ended March 31, 2005 from no income tax expense in the prior year periods. The income tax rate is expected to be approximately 5 percent in fiscal 2005 due primarily to federal and state alternative minimum taxes.

 

LIQUIDITY AND CAPITAL RESOURCES

 

We have financed our operations since inception through sales of equity securities and, to a lesser extent, sales of our Cooled ThermoTherapy system control units and single-use treatment catheters. As of March 31, 2005, we had total cash, cash equivalents and available-for-sale investments of $10.2 million compared to $7.6 million as of June 30, 2004. Working capital increased to $11.1 million at March 31, 2005 from $7.4 million at June 30, 2004.


During the nine months ended March 31, 2005, we generated $2.3 million of cash from operating activities. Our net earnings of $2.3 million combined with depreciation and amortization of $1.4 million were partially offset by a decrease in accrued expenses and deferred income of $1.0 million. The significant decrease in accrued expenses and deferred income resulted primarily from the payment of employee bonuses and fiscal 2004 year-end sales commissions during the first quarter of fiscal 2005. These expenses were accrued in fiscal 2004. Increases in accounts receivable and inventory of $610,000 and $599,000, respectively, were partially offset by a decrease in prepaids and other assets of $473,000 and an increase in accounts payable of $362,000. The increased investment in inventory resulted primarily from an increase in the number of control units produced during the first nine months of fiscal 2005. A portion of this inventory was transferred into property and equipment in support of our customer evaluation and long-term use programs, and a portion remained in inventory at March 31, 2005.

 

During the first nine months of fiscal 2005, we generated $1.6 million from investing activities, resulting from the net sale and maturity of $1.7 million of available-for-sale investments partially offset by the purchase of $92,000 of property and equipment.

 

During the nine months ended March 31, 2005, we generated $338,000 from financing activities as a result of $442,000 of proceeds from the exercise of stock options partially offset by a $104,000 principal payment to EDAP for the retirement of the promissory note associated with the Prostatron acquisition. The final payment on the promissory note was made to EDAP on December 31, 2004.

 

We plan to continue offering customers a variety of programs for both evaluation and long-term use of our Cooled ThermoTherapy system control units in addition to purchase options. As of March 31, 2005, our property and equipment, net, included approximately $2.0 million of control units used in evaluation or long-term use programs. Depending on the growth of these programs, we may use additional capital to finance the units used by these customers.

 

Based upon our financial performance in fiscal 2004 and the first nine months of fiscal 2005, we believe our $10.2 million in cash, cash equivalents, and available-for-sale investments at March 31, 2005, together with the funds generated from operations, will be sufficient to fund our working capital and capital resources needs for the next 12 months. There can be no assurance, however, that we will not require additional financing in the future or that any additional financing will be available to us on satisfactory terms, if at all.


FACTORS THAT MAY AFFECT OUR FUTURE RESULTS AND THE TRADING PRICE OF OUR COMMON STOCK

 

The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our operations. The occurrence of any of the following risks could harm our business. In that case, the trading price of our common stock could decline, and investors may lose all or part of their investment.

 

We are faced with intense competition and rapid technological and industry change.

 

The medical device industry is characterized by rapid technological change, changing customer needs and frequent new product introductions. Our products may be rendered obsolete as a result of future innovations. We face intense competition from other device manufacturers and surgical manufacturers, as well as from pharmaceutical companies. Nearly all of our competitors are significantly larger than we are and have greater financial, technical, research, marketing, sales, distribution and other resources than we do. We believe that price competition will continue among products developed in our markets. Our competitors may develop or market technologies and products, including drug-based treatments that are more effective or commercially attractive than any we are developing or marketing. Our competitors may succeed in obtaining regulatory approval and introducing or commercializing products before we do. Such developments could have a significant negative effect on our financial condition and operating results. Even if we are able to compete successfully, we may not be able to do so in a profitable manner.

 

We have only attained profitability recently.

 

Although we produced net earnings of $2.3 million for the nine months ended March 31, 2005 and $642,000 for the year ended June 30, 2004, we have incurred losses of approximately $77 million since our inception. If physicians do not continue to purchase and use our Cooled ThermoTherapy systems to treat patients with BPH, we may not be able to maintain profitability. Because we will continue to incur additional expenses relating to sales and marketing activities and research and development activities, we will need to increase the revenues we receive from sales of our products in order to continue to operate in a profitable manner. We cannot assure you that we will be able to increase our revenues, maintain profitable operations, or successfully implement our business plan or future business opportunities.

 

Our products may not achieve market acceptance, which could limit our future revenue.

 

Physicians will not recommend Cooled ThermoTherapy procedures unless they conclude, based on clinical data and other factors, that it is an effective alternative to other methods of enlarged prostate treatment, including more established methods. Patient acceptance of the procedure will depend in part upon physician recommendations and on other factors, including the degree of invasiveness and the rate and severity of complications associated with the Cooled ThermoTherapy procedure compared with other therapies. Patient acceptance of the Cooled ThermoTherapy procedure also will depend upon the ability of physicians to educate these patients on their treatment choices. Health care payer acceptance of our procedure will require, among other things, evidence of the cost effectiveness of Cooled ThermoTherapy compared to other BPH therapies. Our marketing strategy must overcome the difficulties inherent in the introduction of new technology to the medical community. If our Cooled ThermoTherapy procedure is not widely accepted by physicians, patients or payers, or is accepted more slowly than expected, our business will be harmed.

 

Third- party reimbursement is critical to market acceptance of our products.

 

Our future revenues are subject to uncertainties regarding health care reimbursement and reform. In the United States, health care providers, such as hospitals and physicians, generally rely on third-party payers. Third-party reimbursement is dependent upon decisions by the CMS, contract Medicare carriers, individual managed care organizations, private insurers, foreign governmental health programs and other payers of health care cost. Failure to receive or maintain favorable coding, coverage and reimbursement determinations for Cooled ThermoTherapy by these organizations could discourage physicians from using our products. We may be unable to sell our products on a profitable basis if third-party payers deny coverage, provide low reimbursement rates or reduce their current levels of reimbursement.


The continuing efforts of government, insurance companies, health maintenance organizations and other payers of health care costs to contain or reduce costs of health care may affect our future revenues and profitability. With recent federal and state government initiatives directed at lowering the total cost of health care, the United States Congress and state legislatures will likely continue to focus on health care reform including the reform of Medicare and Medicaid systems, and on the cost of medical products and services. Additionally, third-party payers are increasingly challenging the prices charged for medical products and services. Also, the trend toward managed health care in the United States and the concurrent growth of organizations such as HMO’s that could control or significantly influence the purchase of health care services and products, as well as legislative proposals to reform health care or reduce government insurance programs, may also result in lower prices for, or rejection of, our products. The cost containment measures that health care payers and providers are instituting and the effect of any health care reform could cause reductions in the amount of reimbursement available, and could have a materially adverse effect on our revenues and ability to operate profitably.

 

We are dependent on adequate protection of our patent and proprietary rights.

 

We rely on patents, trade secrets, trademarks, copyrights, know-how, license agreements and contractual provisions to establish and protect our intellectual property rights. However, these legal means afford us only limited protection and may not adequately protect our rights or provide remedies to gain or keep any advantages we may have over our competitors.

 

We cannot assure you that others may not independently develop the same or similar technologies or otherwise obtain access to our technology and trade secrets. Our competitors, many of which have substantial resources and may make substantial investments in competing technologies, may apply for and obtain patents that will prevent, limit, or interfere with our ability to manufacture or market our products. Further, while we do not believe that any of our products or processes interfere with the rights of others, third parties may nonetheless assert patent infringement claims against us in the future.

 

Costly litigation may be necessary to enforce patents issued to us, to protect trade secrets or “know-how” we own, to defend us against claimed infringement of the rights of others or to determine the ownership, scope, or validity of our proprietary rights and the rights of others. In connection with a patent infringement suit we filed in March 2002, we granted ProstaLund AB, ProstaLund Operations AB, and Circon Corporation (a/k/a ACMI Corporation) a non-exclusive, royalty free license under certain of our patents to sell the ProstaLund transurethral microwave thermotherapy system marketed in the United States by ACMI Corporation as the CoreTherm device.

 

Any claim of infringement against us may involve significant liabilities to third parties, could require us to seek licenses from third parties, and could prevent us from manufacturing, selling, or using our products. The occurrence of this litigation, or the effect of an adverse determination in any of this type of litigation, could have a material adverse effect on our business, financial condition and results of operations.

 

We depend upon our Cooled ThermoTherapy products for all of our revenues.

 

All of our revenues are derived from sales of our Cooled ThermoTherapy system control units and single-use treatment catheters. As a result, our success is solely dependent upon the success of our Cooled ThermoTherapy products. To date, our Cooled ThermoTherapy systems have not achieved widespread market adoption. If we are unable to widely commercialize the use of these systems successfully, our business, financial condition and results of operations will be materially and adversely affected. Further, higher than expected manufacturing, marketing and distribution costs, lower than expected reimbursement levels, lower than expected usage by physicians, and/or other competitive forces may require us to alter our pricing or marketing structure in a manner that could have a material and adverse effect on us.


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.

 

Our business exposes us to potential product liability claims that are inherent in the testing, production, marketing and sale of medical devices. Like other participants in the medical device market, we are from time to time involved in lawsuits, claims and proceedings alleging product liability and related claims such as negligence. If product liability claims become substantial, our reputation could be damaged significantly, thereby harming our business. We may be required to pay substantial damage awards as a result of any successful product liability claims. Any product liability claim against us, whether with or without merit, could result in costly litigation, and divert the time, attention, and resources of our management.

 

As a result of our exposure to product liability claims, we currently carry product liability insurance covering our products with policy limits per occurrence and in the aggregate that we have deemed to be sufficient. We cannot predict, however, whether this insurance is sufficient, or if not, whether we will be able to obtain sufficient insurance to cover the risks associated with our business or whether such insurance will be available at premiums that are commercially reasonable. In addition, these insurance policies must be renewed annually. Although we have been able to obtain liability insurance, such insurance may not be available in the future on acceptable terms, if at all. A successful claim against us or settlement by us in excess of our insurance coverage or our inability to maintain insurance in the future could have a material adverse effect on our business, results of operations, liquidity and financial condition.

 

Our products may be subject to product recalls even after receiving FDA clearance or approval, which would harm our reputation and our business.

 

The FDA and similar governmental authorities in other countries in which our products are sold, have the authority to request and, in some cases, require the recall of our products in the event of material deficiencies or defects in design or manufacture. A government-mandated or voluntary recall by us could occur as a result of component failures, manufacturing errors or design defects. Any recall of product would divert managerial and financial resources, harm our reputation with our customers and damage our business.

 

In December 2003, we determined that a component of one of our Cooled ThermoTherapy system control units may not perform properly under certain conditions. We advised our customers who are using the affected units of an appropriate product protocol to follow pending our implementation of a software solution that will resolve the performance issue. We submitted the software update addressing the problem to the FDA and have received its approval. We completed the installation of the approved software update during the third quarter of fiscal 2005.

 

We have limited manufacturing experience and are dependent upon a limited number of third-party suppliers to manufacture our products.

 

We produce the single-use treatment catheters for the Targis system and in January 2004 we began manufacturing the Targis system control unit. Our success will depend upon our ability to cost-effectively manufacture a reliable product and deliver that product in a timely manner. Because we lack extensive manufacturing experience, we may encounter difficulties in maintaining production efficiencies, quality control and assurance, component supply and qualified personnel. We cannot assure you that we will be able to manufacture a reliable product and deliver that product to customers in a timely fashion. Our failure to maintain a reputation among our customers as a timely, responsive manufacturer or higher than expected manufacturing costs would adversely affect our business.

 

Other than the Targis system control unit and treatment catheters, we outsource all other manufacturing for our products. We assemble Targis control units and treatment catheters using materials and components supplied by various subcontractors and suppliers, as well as components we fabricate. We rely on single sources for several components, one of which is obtained from a source that has a patent for the technology. Our reliance on outside suppliers for our components involves risks including limited control over the price and uncertainty regarding timely delivery and quality of parts. Additionally, we currently have a supply agreement with VTI Corporation (formerly Venusa) for the production of the Prostatron single-use treatment catheter that extends though April 2006 with an automatic renewal term.


The termination or interruption of any of these relationships, or the failure of these manufacturers or suppliers to supply products or components to us on a timely basis or in sufficient quantities, likely would cause us to be unable to meet customer orders for our products and harm our reputation with customers and our business. Identifying and qualifying alternative suppliers of components or manufacturers of products takes time and involves significant additional costs and may delay the production of our products. Further, if we obtain a new supplier for a component, manufacture our product with an alternative component or if our products are manufactured by an alternative manufacturer, we may need to obtain FDA approval of a PMA supplement to reflect changes in product manufacturing and the FDA may require additional testing of any component from new suppliers prior to our use of these components. Further, if FDA approval of a PMA supplement is required, any delays in delivery of our product to customers would be extended and our costs associated with the change in product manufacturing would increase.

 

The failure of our third-party manufacturers to manufacture the products for us, and the failure of our components suppliers to supply us with the components, consistent with our requirements as to quality, quantity and timeliness would materially harm our business.

 

We have limited inventory of Prostatron control units and if customer demand exceeds our expectations, we will experience delays and expense in meeting customer demand that could be significant.

 

We have previously contracted with third parties for the production of the Prostatron product line pursuant to written supply agreements. Our supply agreement for the production of the Prostatron control unit with EDAP ended on October 1, 2003. At this time, we do not have plans to enter into another supply agreement for the manufacture of Prostatron control units, as we believe our current inventory of Prostatron control units combined with company owned control units located at customer sites will adequately support future customer requirements. If, for any reason, customer demand exceeds our current projections, we could experience significant delays and expend significant resources in obtaining a new supply agreement with EDAP or another manufacturer to meet this customer demand. Therefore, we are likely to experience significant delays in fulfilling unexpected, significant customer demand for our Prostatron control units.

 

We are dependent on key personnel.

 

Failure to attract and retain skilled personnel could hinder our research and development as well as our sales and marketing efforts. Our future success depends to a significant degree upon the continued services of key technical and senior management personnel, including Fred B. Parks, our Chairman of the Board and Chief Executive Officer. We have an employment agreement with Mr. Parks that provides that Mr. Parks will serve as our Chairman and Chief Executive Officer and that either party may terminate Mr. Parks’ employment at any time with or without cause. If we terminate Mr. Parks’ employment without cause, however, we would be required to make specified payments to him as described in his employment agreement. We do not have key person life insurance on Mr. Parks. Our future success also depends on our continuing ability to attract, retain and motivate highly qualified managerial, technical and sales personnel. Our inability to retain or attract qualified personnel could have a significant negative effect and thereby materially harm our business and financial condition.

 

Government regulation can have a significant impact on our business.

 

Government regulation in the United States and other countries is a significant factor affecting the research and development, manufacture and marketing of our products. In the United States, the FDA has broad authority under the federal Food, Drug and Cosmetic Act and the Public Health Service Act to regulate the distribution, manufacture and sale of medical devices. Sales of medical devices outside the United States are subject to government regulation and restrictions that vary from country to country. The process of obtaining FDA and other required regulatory approvals is lengthy and expensive.


We may not be able to obtain necessary approvals for clinical testing or for the manufacturing or marketing of our products in the United States or in other countries. Failure to comply with applicable regulatory approvals can, among other things, result in fines, suspension of regulatory approvals, product recalls, operating restrictions and criminal prosecution. In addition, government regulations may be established that could prevent, delay, modify or rescind regulatory approval of our products. Any such position or change of position by the FDA may adversely impact our business and financial condition. Regulatory approvals, if granted, may include significant limitations on the indicated uses for which our products may be marketed in the United States or in other countries. In addition to obtaining such approvals, the FDA and foreign regulatory authorities may impose numerous other requirements on us. The FDA prohibits the marketing of approved medical devices for unapproved uses. In addition, product approvals can be withdrawn for failure to comply with regulatory standards or the occurrence of unforeseen problems following initial marketing. We may not be able to obtain regulatory approvals for our products on a timely basis, or at all, and delays in receipt of or failure to receive such approvals, the loss of previously obtained approvals, or failure to comply with existing or future regulatory requirements would have a significant negative effect on our financial condition. In addition, the health care industry in the United States is generally subject to fundamental change due to regulatory, as well as political, influences. We anticipate that Congress and state legislatures will continue to review and assess alternative health care delivery and payment systems. Potential approaches that have been considered include controls on health care spending through limitations on the growth of private purchasing groups and price controls. We cannot predict what impact the adoption of any federal or state health care reform measures may have on our business.

 

We, along with our distributors and health care providers who purchase our products and services, are subject to state and federal laws prohibiting kickbacks or other forms of bribery in the health care industry. We may be subject to civil and criminal prosecution for violations of any of these laws by our agents or us.

 

We have limited cash resources and may not have additional financing available to us.

 

We generated approximately $2.3 million of cash and cash equivalents from operating activities in the nine month period ended March 31, 2005 and ended that period with approximately $10.2 million of cash, cash equivalents, and available-for-sale investments. We believe our $10.2 million in cash, cash equivalents, and available-for-sale investments, together with the funds generated from product sales, will be sufficient to fund our working capital and capital resource needs for the next 12 months. Our business plan and financing needs are subject to change depending on, among other things, success of our efforts to continue to effectively manage expenses, market conditions, business opportunities and cash flow from operations, if any. We may require additional financing to continue our business, the receipt of which cannot be assured. Such additional financing could be sought from a number of sources, including possible sales of equity or debt securities or loans from banks or other financial institutions. We may not be able to obtain additional financing from any source on reasonable terms, if at all. Any future capital that is available may be raised on terms that are dilutive to our shareholders.

 

Fluctuations in our future operating results may negatively affect the market price of our common stock.

 

Our operating results have fluctuated in the past and can be expected to fluctuate from time to time in the future. Some of the factors that may cause these fluctuations include but are not limited to:

 

    the timing, volume and pricing of customer orders for both control units and single-use treatment catheters,

 

    the impact to the marketplace of competitive products and pricing,

 

    costs and expenses related to our effort to protect our intellectual property,

 

    the timing of expenditures related to sales and marketing, and research and development, and

 

    product availability.

 

If our operating results are below the expectations of securities analysts or investors, the market price of our common stock may fall abruptly and significantly.


Our stock price may be volatile and a shareholder’s investment could decline in value.

 

Our stock price has fluctuated in the past and may continue to fluctuate significantly, making it difficult for an investor to resell shares or to resell shares at an attractive price. The market prices for securities of emerging companies have historically been highly volatile. Future events concerning us or our competitors could cause such volatility, including:

 

    actual or anticipated variations in our operating results,

 

    developments regarding government and third-party reimbursement,

 

    changes in government regulation,

 

    government investigation of us or our products,

 

    changes in reimbursement rates or methods affecting our products,

 

    developments concerning proprietary rights,

 

    litigation or public concern as to the safety of our products or our competitors’ products,

 

    technological innovations or new commercial products introduced by us or our competitors,

 

    investor perception of us and our industry,

 

    general economic and market conditions including market uncertainty,

 

    national or global political events,

 

    public confidence in the securities markets and regulation by or of the securities markets, and

 

    changes in senior management.

 

In addition, the stock market is subject to price and volume fluctuations that affect the market prices for companies in general, and small-capitalization, high-technology companies in particular, which are often unrelated to the operating performance of these companies. Any failure by us to meet or exceed estimates of financial analysts is likely to cause a decline in our common stock price.

 

Future sales of shares of our common stock may negatively affect our stock price.

 

Future sales of our common stock could have a significant negative effect on the market price of our common stock. In addition, upon exercise of outstanding options and warrants, the number of shares outstanding of our common stock could increase substantially. This increase, in turn, could dilute future earnings per share, if any, and could depress the market value of our common stock. Dilution and potential dilution, the availability of a large amount of shares for sale, and the possibility of additional issuances and sales of our common stock may negatively affect both the trading price of our common stock and the liquidity of our common stock. These sales also might make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that we would deem appropriate.

 

Anti-takeover provisions in our articles of incorporation may have a possible negative effect on our stock price.

 

Certain provisions of our certificate of incorporation and bylaws may make it more difficult for a third party to acquire, or discourage a third party from attempting to acquire, control of us. We have in place several anti-takeover measures that could discourage or prevent a takeover, even if an acquisition would be beneficial to our shareholders. Our stock option plans contain provisions that allow for the acceleration of vesting or payments of awards granted under the plans in the event of specified events that result in a “change in control.” In addition, we have adopted a shareholder rights plan that would cause substantial dilution to any person or group attempting to acquire our company on terms not approved in advance by our board of directors.


ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

 

Our financial instruments include cash, cash equivalents, and available-for-sale investments. Our available-for-sale investments at March 31, 2005 are carried at market value. Increases and decreases in prevailing interest rates generally translate into decreases and increases in the fair value of these instruments. Also, fair values of interest rate sensitive instruments may be affected by the credit worthiness of the issuer, prepayment options, relative values of alternative instruments, the liquidity of the instrument and other general market conditions.

 

Market risk was estimated as the potential decrease in fair value resulting from a hypothetical 1% change in interest rates for the issues contained in the available-for-sale investment portfolio and was not materially different from the carrying value at March 31, 2005. Due to the nature of our short-term investments, we have concluded that we do not have a material market risk exposure.

 

Our policy is not to enter into derivative financial instruments. We do not have any significant foreign currency exposure since we do not generally transact business in foreign currencies. Therefore, we do not have significant overall currency exposure. In addition, we do not enter into any futures or forward commodity contracts since we do not have significant market risk exposure with respect to commodity prices.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a) Evaluation of Disclosure Controls and Procedures.

 

The Company’s Chief Executive Officer, Fred B. Parks, and Vice President and Chief Financial Officer, Todd E. Paulson, have evaluated the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon this review, they have concluded that these controls and procedures are effective.

 

(b) Changes in Internal Controls.

 

There have been no changes in internal control over financial reporting that occurred during the fiscal period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

Our business exposes us to product liability claims that are inherent in the testing, production, marketing and sale of medical devices. As a consequence, we are involved in various legal actions in the ordinary course of our business. Although the outcome of any such legal actions cannot be predicted, management believes any losses that may occur from these matters are adequately covered by insurance, subject to applicable deductibles, and that there is no pending legal proceeding against or involving the Company for which the outcome is likely to have a material adverse effect upon the Company’s statement of financial position or results of operations. See “Factors that May Affect our Future Results and the Trading Price of our Common Stock – Our business of the manufacturing, marketing and sale of medical devices involves risk of liability claims and such claims could seriously harm our business, particularly if our insurance coverage is inadequate.”


ITEM 6. EXHIBITS

 

(a) Exhibits

 

Exhibit 31.1    Certification of Chief Executive Officer Pursuant to Section 13a-14 and 15d-14 of the Exchange Act.

 

Exhibit 31.2    Certification of Chief Financial Officer Pursuant to Section 13a-14 and 15d-14 of the Exchange Act.

 

Exhibit 32       Certification pursuant to 18 U.S.C. 1350.


SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

Date May 10, 2005

 

Urologix, Inc.

(Registrant)

 

/s/ Fred B. Parks.


Fred B. Parks

Chairman and Chief Executive Officer

(Principal Executive Officer)

 

/s/ Todd E. Paulson


Todd E. Paulson

Vice President and Chief Financial Officer

(Principal Financial Officer)