Urologix 10Q 2014 Q3 Quarterly report

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, 2014

	or

o	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		(I.R.S. Employer
incorporation or organization)		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 (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. Yesx Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted an posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yesx Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.


Large Accelerated Filero	Accelerated Filero	Non-Accelerated Filero	Smaller Reporting Companyx

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yeso Nox

As of May 1, 2014, the Company had outstanding 21,325,906 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, 2014 (unaudited)			June 30, 2013 (*)
ASSETS
Current Assets:
Cash	$	816		$	2,290
Accounts receivable, net of allowance of $62 and $79, respectively		1,797			2,132
Inventories		1,321			1,571
Prepaids and other current assets		214			128
Total current assets		4,148			6,121
Property and equipment:
Property and equipment		12,177			12,165
Less accumulated depreciation		(11,647	)		(11,430	)
Property and equipment, net		530			735
Other intangible assets, net		1,423			1,587
Goodwill		3,036			3,036
Long-term inventories		172			1,043
Other assets		5			5
Total assets	$	9,314		$	12,527

LIABILITIES AND SHAREHOLDERS’ EQUITY/(DEFICIT)
Current liabilities:
Accounts payable	$	1,015		$	628
Accrued compensation		622			721
Deferred income		9			5
Short-term deferred acquisition payment		1,304			681
Current portion of long-term debt		920			—
Interest payable		78			—
Other accrued expenses		539			602
Total current liabilities		4,487			2,637

Deferred tax liability		63			36
Long-term deferred acquisition payment		3,632			4,026
Long-term debt		4,413			5,333
Other accrued expenses		46			75
Interest payable		167			—
Total liabilities		12,808			12,107
Commitments and Contingencies (Note 14)
SHAREHOLDERS’ EQUITY/(DEFICIT):
Common stock, $.01 par value, 30,000 and 25,000 shares authorized; 21,326 and 20,909 shares issued; and 20,941 and 20,795 shares outstanding		209			208
Additional paid-in capital		119,398			119,230
Accumulated deficit		(123,101	)		(119,018	)
Total shareholders’ equity/(deficit)		(3,494	)		420
Total liabilities and shareholders’ equity/(deficit)	$	9,314		$	12,527

(*) The Balance Sheet at June 30, 2013 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,
	2014			2013			2014			2013
SALES	$	3,356		$	4,082		$	10,941		$	12,405
COST OF GOODS SOLD		2,507			2,056			6,431			6,127
Gross profit		849			2,026			4,510			6,278

COSTS AND EXPENSES
Sales and marketing		1,313			1,915			4,839			5,639
General and administrative		527			711			1,773			2,094
Research and development		408			538			1,281			1,756
Change in value of acquisition consideration		(12	)		—			(105	)		(369	)
Gain on demutualization		—			(321	)		—			(321	)
Medical device tax		52			41			172			41
Amortization of identifiable intangible assets		28			26			72			78
Total costs and expenses		2,316			2,910			8,032			8,918
OPERATING LOSS		(1,467	)		(884	)		(3,522	)		(2,640	)

INTEREST EXPENSE		(178	)		(98	)		(516	)		(348	)
FOREIGN CURRENCY EXCHANGE GAIN/(LOSS)		(1	)		(6	)		1			(9	)
LOSS BEFORE INCOME TAXES		(1,646	)		(988	)		(4,037	)		(2,997	)
INCOME TAX EXPENSE		18			17			46			48
NET LOSS	$	(1,664	)	$	(1,005	)	$	(4,083	)	$	(3,045	)

NET LOSS PER COMMON SHARE - BASIC	$	(0.08	)	$	(0.05	)	$	(0.19	)	$	(0.15	)

NET LOSS PER COMMON SHARE - DILUTED	$	(0.08	)	$	(0.05	)	$	(0.19	)	$	(0.15	)

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - BASIC		21,326			20,902			21,195			20,637

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING - DILUTED		21,326			20,902			21,195			20,637

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

Urologix, Inc.
Condensed Statements of Cash Flows
(Unaudited, in thousands)


	Nine Months Ended March 31,
	2014			2013
OPERATING ACTIVITIES
Net loss	$	(4,083	)	$	(3,045	)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization		447			505
Employee stock-based compensation expense		169			200
Provision for bad debts		(7	)		29
Prostiva inventory reserve		739			—
Loss on disposal of assets		3			7
Accretion expense on deferred acquisition payments		334			439
Net adjustment to acquisition consideration		(105	)		(369	)
Deferred income taxes		27			32
Change in operating assets and liabilities:
Accounts receivable		342			44
Inventories		336			(1,017	)
Prepaids and other assets		(86	)		93
Accounts payable		387			2,607
Accrued expenses and deferred income		(187	)		(75	)
Interest payable		245			—
Net cash used for operating activities		(1,439	)		(550	)

INVESTING ACTIVITIES
Purchases of property and equipment		(28	)		(55	)
Purchases of intellectual property		(7	)		(24	)
Net cash used for investing activities		(35	)		(79	)

FINANCING ACTIVITIES
Proceeds from stock option exercises		—			16
Issuance of common stock		—			3,814
Net cash provided by financing activities		—			3,830

NET INCREASE/(DECREASE) IN CASH		(1,474	)		3,201

CASH
Beginning of period		2,290			1,899
End of period	$	816		$	5,100

Supplemental cash-flow information
Income taxes paid during the period	$	27		$	15
Net carrying amount of inventory transferred to property and equipment	$	46		$	73

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

Urologix, Inc.
Notes to Condensed Financial Statements
March 31, 2014
(Unaudited)


1.	Basis of Presentation

The accompanying unaudited condensed financial statements of Urologix, Inc. (the “Company,” “Urologix,” “we”) have been prepared in accordance with 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, 2014 and the statements of operations and cash flows for the three and nine-months ended March 31, 2014 and 2013 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 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 the Urologix Annual Report on Form 10-K for the year ended June 30, 2013, which includes a going concern qualification.

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.

The condensed balance sheet includes the reclassification of prior year inventory from current inventories to long-term inventories to conform with current year presentation. The reclassification is related to additional inventories received subsequent to the Prostiva acquisition that should have been classified as long-term, as we do not expect to sell them within the next 12 months, which had been classified in current inventories.


2.	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. These estimates and assumptions are based on management’s best estimates and judgments. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors that management believes to be reasonable under the circumstances, including the current economic environment. The Company adjusts such estimates and assumptions when facts and circumstances dictate. These include, among others, the continued difficult economic conditions, tight credit markets, Medicare reimbursement rate uncertainty, and a decline in consumer spending and confidence, all of which have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual amounts could differ significantly from those estimated at the time the financial statements are prepared. Changes in those estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods.


3.	Liquidity

As of March 31, 2014, the Company’s cash balance was $816,000. The Company incurred net losses of $4,083,000 for the nine-month period ended March 31, 2014 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 March 31, 2014 of $123,101,000.

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 then 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, outstanding transition services fees, and 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 31^st 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. The Company does not have adequate cash to repay the full outstanding principal amount of $5.3 million on the Note. Any event of default under the Note may result in a loss of control of our business or bankruptcy.

Urologix, Inc.
Notes to Condensed Financial Statements
March 31, 2014
(Unaudited)

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 March 31, 2014 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 March 31, 2014. In addition, we have not paid, as of March 31, 2014 or as of the date of filing this Quarterly Report on Form 10-Q, the annual $65,000 licensing maintenance fee due on September 6, 2013 which is included in other accrued expenses as of March 31, 2014. 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. In the event of a material breach of the licensing agreement or other transaction documents, and Medtronic provides written notice to the Company and the Company fails to cure the breach, Medtronic may terminate the license agreement. If the license agreement is terminated, the Company’s rights to sell the Prostiva product would be terminated.

On January 11, 2012, the Company entered into a Loan and Security Agreement with Silicon Valley Bank (“SVB”), as subsequently amended (see Footnote 12 for further details). The line of credit with Silicon Valley Bank allows borrowing by the Company of up to the lesser of $2.0 million or the defined borrowing base consisting of 80% of eligible accounts receivable.

The Company will not be able to draw down our line of credit with Silicon Valley Bank upon a material breach of the license agreement or event of default under the Note with Medtronic, or, as of January 30, 2014, payment to Medtronic of any royalty payment or annual license payment or certain other actions by Medtronic with respect to these payments. The terms of the agreement with Silicon Valley bank state that any default with a third party, the result of which could have a material adverse affect on our business, is considered an event of default under the line of credit agreement and as of January 30, 2014, that it is an event of default if the Company makes any royalty payment and/or annual license payment to Medtronic, if Medtronic threatens to take action against the Company to collect any portion of these payments, or if Medtronic commences any action or proceeding against the Company with respect to these payments. The Company may cure this event of default by receipt within 30 days of its occurrence of net proceeds from a new round of equity or subordinated debt financing of at least $715,000.

In addition, in accordance with a letter agreement between the Company and Medtronic dated March 21, 2014, the Company will not draw down any funds under its line of credit with Silicon Valley Bank without prior approval from Medtronic. The line of credit expires by its terms on June 30, 2014. As of March 31, 2014 the Company has not borrowed against this facility.

During the first quarter of fiscal 2013, 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 resulted in 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. As of March 31, 2014, the Company’s cash may not be sufficient to sustain day-to-day operations for the next 12 months. The Company’s ability to continue as a going concern is dependent upon our ability to generate positive cash flows from our business, maintain available borrowing under our line of credit with Silicon Valley Bank, and aggressively manage our expenses including those associated with our acquisition of the Prostiva product line from Medtronic. The Company’s ability to continue as a going concern is also dependent upon avoiding an event of default under the Note and avoiding termination of the license relating to the Prostiva product, whether by negotiation with Medtronic, cure of any non-payment giving rise to an event of default or termination, or otherwise.

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 restructuring plans in January 2014 and again in April 2014 to reduce our cash utilization (see Footnote 13 for further details). The Company estimates that as a result of the restructurings, it will be able to reduce cost of goods sold and pre-tax operating expenses in total by more than $4.0 million annually, beginning in the fourth quarter of fiscal year 2014. The Company may also seek to improve its liquidity position by raising capital through additional indebtedness or an offering of its equity securities or both.

There is no assurance that our cash, cash generated from operations, if any, and available borrowing under our agreement with Silicon Valley Bank will be sufficient to fund our anticipated capital needs, operating expenses (including payments under the licensing 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.

Urologix, Inc.
Notes to Condensed Financial Statements
March 31, 2014
(Unaudited)

If the Company is unable to generate sufficient liquidity to meet its needs and in a timely manner, the Company may be required to further reduce expenses and curtail capital expenditures, sell assets, or suspend or discontinue operations. In addition, there can be no assurance that the Company will be able to cure any potential event of default of the Note or cure any breach of any agreement with Medtronic, maintain compliance with its agreements with Medtronic, access available borrowings under the line of credit with Silicon Valley Bank, raise additional capital, or improve its operating or financial performance.

The financial statements as of and for the three and nine-months ended March 31, 2014 do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result should the Company be unable to continue as a going concern.


4.	Fair Value Measurements

The Company follows the authoritative guidance on fair value measurements and disclosures with respect to assets and liabilities that are measured at fair value on both a recurring and non-recurring basis. Under this guidance, fair value is defined as the exit price, or the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants as of the measurement date. The authoritative guidance also establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. The hierarchy is broken down into three levels defined as follows:


	•	Level 1 - Inputs are quoted prices in active markets for identical assets or liabilities.

	•	Level 2 - Inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active and inputs (other than quoted prices) that are observable for the asset or liability, either directly or indirectly.

	•	Level 3 - Inputs are unobservable for the asset or liability.

As part of the consideration for the Prostiva acquisition, the estimated royalty payments between the minimum and maximum amounts are considered contingent consideration. The contingent consideration was measured at fair value at the acquisition date and is remeasured to fair value at each reporting date until the contingency is resolved using Level 3 inputs. The Level 3 inputs consist of the projected fiscal year of payments based on projected revenues and an estimated discount rate. The fair value is determined by applying an appropriate discount rate that reflects the risk factors associated with the payment streams. The changes in fair value that do not relate to the initial recognition of the liability as of the acquisition date are recognized in earnings. The Company estimates the fair value of the future contingent consideration at $1.4 million as of March 31, 2014. The Company recognized a reduction in fair value of contingent consideration of $105,000 during the nine-month period ended March 31, 2014 as a result of a reduction in the projected royalty payments in excess of contractual minimums. There was no change in the fair value of non-contingent consideration. The following table provides a reconciliation of the beginning and ending balances of the contingent consideration liability:


(in thousands)	Nine months ended March 31, 2014
Beginning Balance	$	1,471
Accretion expense		63
Change in fair value of contingent consideration		(105	)
Ending Balance	$	1,429

Urologix, Inc.
Notes to Condensed Financial Statements
March 31, 2014
(Unaudited)


5.	Stock-Based Compensation

On November 16, 2012, our shareholders approved a new equity compensation plan, the Urologix, Inc. 2012 Stock Incentive Plan (the “2012 Plan”). The 2012 Plan replaced our Amended and Restated 1991 Stock Option Plan (the “1991 Plan”) and provides stock incentive awards in the form of options (incentive and non-qualified), stock appreciation rights, restricted stock, restricted stock units, performance stock, performance units, and other awards in stock and/or cash. As of March 31, 2014, we had reserved 1,825,390 shares of common stock under the 2012 Plan, which includes 225,390 expired and forfeited shares from the 1991 Plan, and 1,211,916 shares were available for future grants. The number of shares available under the 2012 Plan will be increased by an amount equal to the number of shares subject to awards or options granted under the 1991 Plan which would have become available for additional awards under the 1991 Plan by reason of forfeiture, cancellation, expiration or termination of those awards. Options expire 10 years from the date of grant and typically vest 25 percent after the first year of service with the remaining vesting 1/36th each month thereafter.

Amounts recognized in the financial statements for the three and nine-months ended March 31, 2014 and 2013 related to stock-based compensation were as follows (in thousands):


	Three months ended March 31,				Nine months ended March 31,
	2014		2013		2014		2013
Cost of goods sold	$	2	$	4	$	7	$	15
Sales and marketing		12		10		40		32
General and administrative		27		29		102		132
Research and development		6		6		20		21
Total stock-based compensation	$	47	$	49	$	169	$	200

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. We use historical data to estimate expected volatility, the period of time that option grants are expected to be outstanding, as well as employee termination behavior. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. The following assumptions were used to estimate the fair value of options granted during the nine-months ended March 31, 2014 and 2013 using the Black-Scholes option-pricing model:


	2014			2013
Volatility		83.66	%		71.83	%
Risk-free interest rate		0.67	%		0.38	%
Expected option life		3.1 years			3.4 years
Stock dividend yield		—			—

A summary of our option activity for the nine-months ended March 31, 2014 is as follows:


	Number of Options			Weighted-avg. Exercise Price Per Option		Weighted-avg. Remaining Contractual Term		Aggregate Intrinsic Value
Outstanding at July 1, 2013		1,711,430		$	1.43			$	—
Options granted		191,500			0.38
Options forfeited		(47,663	)		0.70
Options expired		(96,287	)		1.55
Options exercised		—			—
Outstanding at March 31, 2014		1,758,980		$	1.33		5.18	$	—
Exercisable at March 31, 2014		1,386,412		$	1.51		4.27	$	—

Urologix, Inc.
Notes to Condensed Financial Statements
March 31, 2014
(Unaudited)

There is no intrinsic value in the table above as our closing stock price of $0.16 and $0.17 on March 31, 2014 and June 28, 2013, respectively, the last trading day prior to June 30, 2013, was lower than all options outstanding and exercisable as of that date.

On August 14, 2013, the Compensation Committee recommended and the Board of Directors approved an award of restricted stock to each non-employee director serving as a member of the Board immediately after the 2013 Annual Meeting, with the number of shares of restricted stock equal to $22,500 divided by the closing price of our common stock on the date of the Annual Meeting, rounded up to the next whole share, subject to a maximum of 50,000 shares per non-employee director. A total of 200,000 restricted stock awards were granted under the 2012 Plan on November 7, 2013, the date of the Annual Meeting or 50,000 shares of restricted stock to each of the Company’s four non-employee directors. The restrictions on the restricted stock will lapse on the first business day immediately prior to the date of the 2014 Annual Meeting of Shareholders if the director is serving as a director as of such date.

On August 14, 2013, the Company’s Board of Directors approved a grant of restricted stock to employees totaling 177,500 shares. The restrictions on the restricted stock lapse on the one year anniversary of the grant date. In addition, as part of our fiscal year 2014 corporate bonus plan, the Company’s Board of Directors approved a plan in which bonus eligible employees will receive shares of the Company’s common stock rather than cash compensation if certain fiscal year 2014 revenue objectives are achieved. If the Company met 100 percent of our fiscal year 2014 revenue performance target, approximately 337,000 shares of the Company’s common stock would be paid out as compensation. None of these shares are currently included in outstanding stock as of March 31, 2014 as the performance period has not yet ended and therefore no shares have been issued.

A summary of restricted stock award activity for the nine-month period ended March 31, 2014 is as follows:


	Number of Restricted Stock Awards			Weighted-avg. Grant-Date Fair Value
Non-vested at June 30, 2013		113,667		$	0.68
Awards granted		377,500			0.28
Awards forfeited		—			—
Awards vested		(106,064	)		0.66
Non-vested at March 31, 2014		385,103		$	0.30

As of March 31, 2014, total unrecognized compensation cost related to non-vested stock options and restricted stock awards granted under the Plan was $109,000 and $51,000, respectively. That cost is expected to be recognized over a weighted-average period of 2.1 years for non-vested stock options and 3.3 years for restricted stock awards.


6.	Basic and Diluted Loss Per Share

Basic loss per share is computed by dividing the net loss by the weighted average number of shares of common stock and participating securities outstanding during the periods presented. Diluted loss per share is computed by dividing the net loss by the weighted average number of shares of common stock and participating securities outstanding plus all dilutive potential common shares that result from stock options. The weighted average common shares outstanding for both basic and dilutive (in thousands), were 21,326 and 20,902, for the three-months ended March 31, 2014 and 2013, respectively and 21,195 and 20,637, for the nine-months ended March 31, 2014 and 2013, respectively.

The dilutive effect of stock options excludes approximately 1.79 million and 1.74 million awards for the three-months ended March 31, 2014 and 2013, respectively, and 1.81 million and 1.74 million for the nine-months ended March 31, 2014 and 2013, respectively, for which the exercise price was higher than the average market price. In addition, there were no potentially dilutive stock options where the exercise price was lower than the average market price for the three and nine-month periods ended March 31, 2014. For the three and nine-month periods ended March 31, 2013, 1,730 and 3,169, respectively, of potentially dilutive stock options, where the exercise price was lower than the average market price, were excluded from diluted weighted average common shares outstanding as they would be anti-dilutive due to the Company’s net loss for such periods.

Urologix, Inc.
Notes to Condensed Financial Statements
March 31, 2014
(Unaudited)


7.	Goodwill

The Company had approximately $3,036,000 of goodwill as of March 31, 2014 related to the acquisition of the Prostiva RF Therapy System on September 6, 2011. Goodwill is tested for impairment annually on April 30th or more frequently if changes in circumstance or the occurrence of events suggests an impairment may exist.

As a result of the change in fair value of acquisition consideration due to an increase in the projected time to reach the cumulative $10 million of royalty and license fees related to the Prostiva acquisition, as well as the continued decline of our stock price, we tested goodwill for impairment as of March 31, 2014. Based on this impairment testing, it was determined that there was no impairment of goodwill as the fair value of the reporting unit exceeded its carrying amount as of March 31, 2014.


8.	Intangible Assets

Intangible assets as of March 31, 2014 and June 30, 2013 consisted of the following (in thousands):


	March 31, 2014										June 30, 2013
	Carrying Value		Accumulated Amortization			Impairment			Net Carrying Value		Carrying Value		Accumulated Amortization			Impairment			Net Carrying Value
Prostiva Acquisition
Patents and Technology	$	1,529	$	(410	)	$	(274	)	$	845	$	1,529	$	(311	)	$	(274	)	$	944
Customer Base		531		(143	)		(95	)		293		531		(108	)		(95	)		328
Trademarks		325		(49	)		(65	)		211		325		(37	)		(65	)		223
EDAP Acquisition
Customer Base		2,300		(2,288	)		—			12		2,300		(2,270	)		—			30
Other		72		(10	)		—			62		64		(2	)		—			62
Total intangible assets	$	4,757	$	(2,900	)	$	(434	)	$	1,423	$	4,749	$	(2,728	)	$	(434	)	$	1,587

Amortization expense associated with intangible assets for the three and nine-months ended March 31, 2014 and 2013 was $61,000 and $68,000, respectively and $172,000 and $205,000, respectively. As a result of the delisting of our common stock from the NASDAQ exchange at the start of trading on June 7, 2013 and the continued decline of our stock price, we tested our long-lived assets and goodwill for impairment as of June 30, 2013. Based on this impairment testing it was determined that our intangible assets acquired as part of the Prostiva acquisition were impaired. As a result, we recorded an impairment charge as of June 30, 2013 of $274,000 on our developed technology asset which was recorded in cost of goods sold, a $95,000 impairment charge on our customer base asset and a $65,000 impairment charge on trademarks both of which were recorded in operating expense. The fair value of patents and technology, customer base and trademark intangible assets was determined based on a discounted cash flow analysis of forecasted future operating results. We once again tested our intangible assets for impairment as of March 31, 2014 as a result of the continued decline in our stock price, net losses and negative cash flows and found no additional impairment existed.

All intangible assets are amortized using the straight-line method over their estimated remaining useful lives. Patents and technology related to the Prostiva acquisition are being amortized over 9 years with amortization expense recorded in cost of goods sold. Customer base and trademarks related to the Prostiva acquisition are being amortized over 9 years and 16 years, respectively. The customer base related to the EDAP acquisition, completed in October of 2000, has a remaining useful life of less than a year, and other intangible assets related to patent costs are amortized upon issuance over their estimated useful lives.

Urologix, Inc.
Notes to Condensed Financial Statements
March 31, 2014
(Unaudited)

Future amortization expense related to the net carrying amount of intangible assets is estimated to be as follows (in thousands):


Fiscal Years
2014	$	55
2015		202
2016		196
2017		196
2018		196


9.	Inventories

Inventories are stated at the lower of cost or market on a first-in, first-out (FIFO) basis and consist of (in thousands):


	March 31, 2014		June 30, 2013

Raw materials	$	720	$	734
Work-in-process		219		112
Finished goods		554		1,768
Total inventories	$	1,493	$	2,614

As of March 31, 2014, we took a non-cash write-down of our Prostiva capital equipment inventory of approximately $739,000, which included approximately $611,000 of finished goods inventory acquired as part of the September 6, 2011 Prostiva acquisition. The write-down of the Prostiva capital equipment inventory was due to low volume sales of the Prostiva generators and scopes, as well as the implementations of the recent restructurings that occurred in January and April of fiscal year 2014 as a result of our change in sales strategy. In addition, approximately $172,000 and $1.0 million of the above finished goods balance as of March 31, 2014 and June 30, 2013, respectively, represents long-term inventories that the Company does not expect to sell within the next 12 months, however they are also not considered excess or obsolete.


10.	Income Taxes

As of June 30, 2013, the liability for gross unrecognized tax benefits was $14,000. During the nine-months ended March 31, 2014, there were no significant changes to the total gross unrecognized tax benefits. It is expected that the amount of unrecognized tax benefits for positions which the Company has identified will not change significantly in the next twelve months.

The Company files income tax returns in the United States (U.S.) federal jurisdiction as well as various state jurisdictions. The Company is subject to U.S. federal income tax examinations by tax authorities for fiscal years after 1998 due to unexpired net operating loss carryforwards originating in and subsequent to that fiscal year. The Company may also be subject to state income tax examinations whose regulations vary by jurisdiction.


11.	Warranty

Some of the Company’s products, including the Prostiva products, are covered by warranties against defects in material and workmanship for periods of up to 24 months. The Company records a liability for warranty claims during the period of the 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 to sales, the historical length of time between the sale and resulting warranty claim, and other factors.

Warranty provisions and claims for the nine-months ended March 31, 2014 and 2013 were as follows (in thousands):



	Beginning		Warranty		Warranty			Ending
Nine Months Ended	Balance		Provisions		Claims			Balance

March 31, 2014	$	58	$	35	$	(30	)	$	63

March 31, 2013	$	47	$	39	$	(40	)	$	46

Urologix, Inc.
Notes to Condensed Financial Statements
March 31, 2014
(Unaudited)


12.	Financing Arrangements

Line of Credit

On January 11, 2012, the Company entered into a Loan and Security Agreement with Silicon Valley Bank (“SVB”). Under the Loan Agreement, SVB will make revolving advances to the Company of the lesser of $2.0 million or the defined borrowing base consisting of 80% of eligible accounts. The Loan and Security Agreement was amended on November 30, 2012, January 9, 2014 (the Second Amendment) and again on January 30, 2014 (the Third Amendment). The Third Amendment extended the maturity date of the revolving line of credit to June 30, 2014. In addition, the Company agreed to a financial covenant requiring that it maintain at least four months of “Cash Burn,” which is the Company’s average monthly income (as defined in the Third Amendment) for the trailing three month period plus certain expenses and less certain non-cash gains. The Third Amendment also amends the interest rate applicable to borrowings under the revolving line to a floating per annum rate equal to either the prime rate plus 3.25% or the prime plus 4.25%, depending upon a financial ratio of certain assets to certain liabilities. Interest is payable monthly. In connection with the Loan Agreement, the Company granted SVB a first priority security interest in certain properties, rights and assets of the Company, specifically excluding intellectual property. In addition, in accordance with a letter agreement between the Company and Medtronic dated March 21, 2014, the Company will not draw down any funds under its line of credit with Silicon Valley Bank without prior approval from Medtronic. As of March 31, 2014, the Company had no borrowings outstanding on this credit line and was in compliance with all covenants.

Promissory Note

On June 28, 2013, the Company 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 principal amount of the Note accrues at the annual rate of 6 percent, compounded annually. The Note requires that the Company make five equal annual payments of principal, plus accrued interest, on March 31 of each year beginning March 31, 2015. All amounts under the Note are due and payable on March 31, 2019 or earlier upon a Change of Control (as defined in the Note). The Company may prepay the Note without penalty at any time. The Note is junior to the indebtedness of Urologix to Silicon Valley Bank (the “Senior Lender”) pursuant to the Loan and Security Agreement dated January 11, 2012, (as subsequently amended), to successors and assigns of the Senior Lender under certain other loan agreements, and to a new lender that provides certain refinancing, but is senior in all respects (including right of payment) to all other existing or future indebtedness. The Note also specifies certain customary events of default that will entitle Medtronic, after any required notice, to declare the outstanding obligations immediately due and payable. The Note contains customary representations, warranties and covenants by the Company. As of March 31, 2014, the Company’s non-payment of an aggregate of $715,000 under the license agreement was not an event of default under the Note because Medtronic had not provided written notice and an opportunity to cure such default.

Pursuant to the terms of a Security Agreement dated as of June 28, 2013 by and between Urologix and Medtronic, the Company’s obligations under the Note are secured by a security interest in all of the Company’s assets, specifically excluding intellectual property (but including accounts receivable and proceeds of intellectual property).

Medtronic’s rights under the Note and Security Agreement are subordinate to the rights of the Senior Lender as set forth in a Subordination Agreement dated as of June 28, 2013 by and between Medtronic and the Senior Lender. We are not a party to the Subordination Agreement. Under the Subordination Agreement, all debt of Urologix to Medtronic is subordinate in right of payment to debt of Urologix to the Senior Lender. Until any debt to the Senior Lender is paid in full, the Senior Lender has no commitment or obligation to lend any further funds to us, and all financing agreements between the Senior Lender and us are terminated, Medtronic may not demand or receive payments on the Note or bring any action against us relating to the Note, except that so long as no event of default exists under the Loan Agreement, Medtronic may receive regularly scheduled payments of principal and interest. Further, pursuant to the Subordination Agreement, Medtronic subordinates any security interest it may have in the Company’s property to the Senior Lender’s security interest in our property, which will at all times be senior to the security interest of Medtronic. Each of Medtronic and the Senior Lender agreed on the respective maximum principal amount of our indebtedness to it, which may not be increased without the consent of the other.

Urologix, Inc.
Notes to Condensed Financial Statements
March 31, 2014
(Unaudited)


13.	Restructuring

On January 3, 2014, the Company implemented a restructuring plan, reorganizing the Company’s operations and sales departments. The restructuring expenses totaled approximately $41,000, of which $24,000 are included in cost of goods sold and $17,000 are included in operating expense for the third quarter of fiscal year 2014. A summary of the third quarter restructuring activity is as follows:


	Employee Termination Costs

Balance as of December 31, 2013	$	—
Restructuring charges		41
Payments		(40	)
Balance as of March 31, 2014	$	1

On April 10, 2014, the Company implemented a second restructuring plan, making additional changes to the Company’s operations and sales departments. The restructuring included another reduction in work force and severance payments of approximately $44,000 which will be included in cost of goods sold and operating expense for the fourth quarter of fiscal year 2014.

These restructurings were part of a strategic decision to refocus the allocation of company resources and improve the Company’s ability to achieve profitability and generate positive cash flow from operations. The Company estimates that as a result of these restructurings, it will be able to reduce cost of goods sold and pre-tax operating expenses in total by more than $4.0 million annually, beginning in the fourth quarter of fiscal year 2014.


14.	Commitments and Contingencies

Legal Proceedings

The Company has been involved in various legal proceedings and other matters that arise in the normal course of its business, including product liability claims that are inherent in the testing, production, marketing and sale of medical devices. As of March 31, 2014, the Company was not involved in any legal proceedings or other matters that are expected to have a material effect on the financial position, liquidity or results of operations of the Company.


15.	Recently Issued Accounting Pronouncements

In July 2013, the FASB issued amended guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. The guidance requires an unrecognized tax benefit, or a portion of an unrecognized tax benefit, to be presented as a reduction of a deferred tax asset when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists, with certain exceptions. The requirements are effective for annual reporting periods beginning after December 15, 2013. We do not anticipate the adoption of this statement to have an impact on our financial position or results of operations.


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

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 September 30, 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 nine-months ended March 31, 2014 and 2013. 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,

	•	Build upon the evidence supporting the cost effectiveness of our technologies and educate healthcare providers on the benefit to patients and the healthcare system of our in-office therapies,

	•	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.

Our marketing and patient education efforts are focused on four 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; (iii) exposing urologists to the significant patient need for effective non-surgical alternatives to medical management; and (iv) providing new evidence to educate provider networks and payers as to the cost effectiveness of our technologies. We employ specific tools to support each of these goals. For the first, this includes developing a well trained clinically oriented field sales team 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. For the fourth, we are working with our healthcare partners to complete new research showing the cost effectiveness of our technologies.

The Company made the strategic decision to restructure the organization, including deploying a new distribution model and operational structure to refocus the allocation of company resources and improve the Company’s ability to achieve profitability and generate positive cash flow from operations. On April 10, 2014 we completed the implementation of this plan. The strategic reorganization included implementing a leaner and more efficient sales team which will continue to support our customer base in a deployment designed to create a more profitable sales model. In addition, we have dedicated resources charged with pursuing new opportunities to expand our business by targeting large provider organizations such as ACOs and certain hospital systems which are highly-focused on cost-effective treatment alternatives like our in-office BPH technologies. The sum of the April 10, 2014 announced strategic restructuring and the January 8, 2014 announced strategic restructuring is expected to generate over $4 million in annualized expense reductions and to prove our ability as a Company to demonstrate our value proposition in this evolving healthcare system.

We initiated sales of the Prostiva RF Therapy system in Europe by entering into supply agreements with distributors in targeted countries. Total international Prostiva sales for the three and nine-month periods ended March 31, 2014 and 2013 were $93,000 and $136,000, respectively, and $258,000 and $420,000, 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 $52,000 and $172,000, respectively, in medical device excise tax for the three-and nine month periods ended March 31, 2014, and $41,000 for the three and nine-month periods ended March 31,2013. This significant increase in the tax burden on our industry could have a material, negative impact on our results of operations and our cash flows.

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.

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 31^st 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 March 31, 2014 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 March 31, 2014. In addition, we have not paid, as of March 31, 2014 and as of the date of filing this Quarterly Report on Form 10-Q, the annual $65,000 licensing maintenance fee due on September 6, 2013 which is included in other accrued expenses as of March 31, 2014. 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 resulted in 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 restructuring plans in January 2014 and again in April 2014 to reduce our cash utilization (see Footnote 13 for further details). The Company estimates that as a result of the restructurings, it will be able to reduce cost of goods sold and pre-tax operating expenses in total by more than $4.0 million annually, beginning in the fourth quarter of fiscal year 2014. 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 theManagement’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. As of March 31, 2014, 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 March 31, 2014 were $3.4 million, compared to $4.1 million during the same period of the prior fiscal year. The $726,000, or 18 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 nine-months ended March 31, 2014 were $10.9 million, compared to $12.4 million for the nine-months ended March 31, 2013. The decrease in net sales of $1.5 million, or 12 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 March 31, 2014 increased $451,000, or 22 percent, to $2.5 million, from $2.1 million for the three-month period ended March 31, 2013. Costs of goods sold of $6.4 million for the nine-month period ended March 31, 2014 increased by $304,000 or 5 percent, compared with the $6.1 million reported for the nine-month period ended March 31, 2013. The increase in costs of goods sold for the three and nine-months ended March 31, 2014 is a result of the $739,000 non-cash write-down of Prostiva capital equipment inventory as a result of lower volume generator and scope sales, as well as the implementations of the recent restructurings that occurred in January and April of fiscal year 2014 as a result of our change in sales strategy. In addition, we incurred approximately $24,000 of expense related to the restructuring plan implemented in January 2014. These increases were partially offset by decreases in costs of goods sold as a result of the decrease in sales.

Gross profit as a percentage of net sales decreased to 25 and 41 percent, respectively, for the three and nine-month periods ended March 31, 2014 from 50 percent and 51 percent, respectively, for the three and nine-month periods ended March 31, 2013. The gross margin rate for the three and nine-month periods ended March 31, 2014 was impacted by 22 percentage points and 7 percentage points, respectively, as a result of the $739,000 Prostiva capital equipment write-down mentioned above. The remaining decrease in gross profit as a percentage of sales is due to higher manufacturing costs per unit due to lower production volumes and higher Prostiva material costs.

Sales and Marketing

Sales and marketing expense of $1.3 million for the third quarter of fiscal year 2014 decreased by $602,000, or 31 percent, when compared to sales and marketing expense of $1.9 million in the same period of fiscal 2014. The decrease in sales and marketing expense for the three-months ended March 31, 2014 is due to a $361,000 decrease in headcount related expenses due to decreased commissions and decreased headcount as a result of the restructuring plan implemented in January 2014. In addition, travel expenses decreased by $83,000 due to lower headcount, advertising and promotions decreased by $71,000, and meeting expenses decreased by $35,000. These decreases were partially offset by approximately $17,000 of expense related to the restructuring previously mentioned.

Sales and marketing expense of $4.8 million for the nine-month period ended March 31, 2014 decreased $800,000, or 14 percent, when compared to sales and marketing expense of $5.6 million in the same period of fiscal 2013. The decrease in sales and marketing expense year-over-year is largely due to decreased wage and benefit and travel related expenses of $446,000 due to decreased headcount, partially as a result of the restructuring plan implemented in January 2014. In addition, marketing expenses decreased by $202,000 and meeting expenses decreased by $90,000.

General and Administrative

General and administrative expense decreased $184,000, or 26 percent, to $527,000 for the three-month period ended March 31, 2014 compared to $711,000 for the three-month period ended March 31, 2013. The decrease in general and administrative expense is a result of decreased spending in all general and administrative areas in an effort to manage expenses. In particular, wages and benefits decreased $83,000 due to lower headcount, and public reporting fees decreased $29,000 as a result of our Nasdaq delisting and no longer needing to pay the related listing fees.

For the nine-months ended March 31, 2014, general and administrative expense decreased $321,000 or 15 percent to $1.8 million from $2.1 million for the nine-month period ended March 31, 2013. The decrease in general and administrative expense is again a result of a decrease in wages and benefits of $254,000 due to lower headcount, a $68,000 decrease in public reporting and investor relation fees, and a $30,000 decrease in stock option expense, partially offset by an increase in consulting fees of $60,000.

Research and Development

Research and development expense, which includes expenditures for product development, regulatory compliance and clinical studies, decreased $130,000 or 24 percent to $408,000 for the three-month period ended March 31, 2014 from $538,000 for the three-month period ended March 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 wages and benefits of $47,000 due to lower headcount in the current year.

For the nine-months ended March 31, 2014, research and development expense decreased $475,000, or 27 percent, to $1.3 million from $1.8 million for the nine-month period ended March 31, 2013. The decrease in research and development expense year-over-year is a result of a $270,000 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 $12,000 and $105,000, respectively, for the three and nine-month periods ended March 31, 2014, compared to zero and $369,000 for the three and nine- month periods ended March 31, 2013, respectively. For the three and nine-month periods ended March 31, 2014, the change in the value of acquisition consideration represents the reduction in fair value of contingent consideration of $12,000 and $105,000, respectively, as a result of a reduction in the projected royalty payments in excess of contractual minimums in earlier years. For the nine-month period ended March 31, 2013, the change in the value of acquisition consideration represents the net effect of a reduction in fair value of contingent consideration of $791,000, partially offset by an increase of $422,000 in non-contingent consideration. These changes were due to an increase in the projected time it would take the Company to reach the cumulative $10 million of royalty and license fees owed on the Prostiva acquisition, which increased the number of years subject to minimum royalty payments and reduced the projected royalty payments in excess of contractual minimums in earlier years.

Gain on Demutualization

The gain on demutualization of $321,000 for the three and nine-month periods ended March 31, 2013 represents the gain resulting from the demutualization of our products liability insurance carrier. This event did not repeat in the current fiscal year period.

Medical Device Tax

The medical device tax expense 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. The medical device excise tax expense of $52,000 for the three-month period ended March 31, 2014, increased by $11,000 or 27 percent, when compared to medical device excise tax expense of $41,000 for the three-months ended March 31, 2013. The increase in the medical device tax expense is due to the fact that we did not become the legal manufacturer of the Prostiva product line until April 2013, and therefore did not pay excise tax on these sales in the prior year period. Medical device excise tax expense of $172,000 for the nine-month period ended March 31, 2014, increased by $131,000 or 320 percent due to the fact that the medical device tax was not implemented until January, 2013 and therefore only represents 3 months of expenses versus 9 months of expense in the current year period.

Amortization of Identifiable Intangible Assets

Amortization of identifiable intangible assets was $28,000 and $26,000 for the three-month period ended March 31, 2014 and 2013, respectively. Amortization of identifiable intangible assets was $72,000 and $78,000 for the nine-month period ended March 31, 2014 and 2013, respectively. The slight increase in amortization expense of the three-month period ended March 31, 2014 is due to the write-off of capitalized patents. The slight decrease in amortization expense for the nine-month period ended March 31, 2014 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 $98,000 for the three-months ended March 31, 2014 and 2013, respectively. For the nine-months ended March 31, 2014, interest expense increased $168,000 to $516,000 from $348,000 for the nine-months ended March 31, 2013. The increase in interest expense is due to accrued interest on the Medtronic Note 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 $18,000 and $46,000 for the three and nine-months ended March 31, 2014, respectively, compared to income tax expense of $17,000 and $48,000 for the three and nine-month periods ended March 31, 2013, respectively. The tax expense in the three and nine-months ended March 31, 2014 consists of $9,000 and $27,000, respectively, of deferred tax expense recorded on the amortization for tax purposes of indefinite-lived goodwill intangibles acquired in the Prostiva acquisition, as well as $9,000 and $19,000, respectively, for state taxes. The tax expense in the three and nine-month periods ended March 31, 2013 also relates to the deferred tax liability resulting from the amortization for tax purposes of the goodwill acquired in the Prostiva acquisition, as well as provisions for state taxes.

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

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations since inception through sales of equity securities, including a follow-on offering completed during the first quarter of fiscal year 2013 and, to a lesser extent, sales of our Cooled ThermoTherapy products and, beginning September 6, 2011, sales of the Prostiva RF Therapy System product. As of March 31, 2014, our cash balance was $816,000.

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 31^st 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. The Company does not have adequate cash to repay the full outstanding principal amount of $5.3 million on the Note. Any event of default under the Note may result in a loss of control of our business or bankruptcy.

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 March 31, 2014 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 March 31, 2014. In addition, we did not pay, as of March 31, 2014 and as of the date of filing this Quarterly Report on Form 10-Q, the annual $65,000 licensing maintenance fee due on September 6, 2013 which is included in other accrued expenses as of March 31, 2014. 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. In the event of a material breach of the licensing agreement or other transaction documents, and Medtronic provides written notice to the Company and the Company fails to cure the breach, Medtronic may terminate the license agreement. If the license agreement is terminated, the Company’s rights to sell the Prostiva product would be terminated.

On January 11, 2012, the Company entered into a Loan and Security Agreement with Silicon Valley Bank, as subsequently amended. The line of credit with Silicon Valley Bank allows borrowing by the Company of up to the lesser of $2.0 million or the defined borrowing base consisting of 80% of eligible accounts receivable.

During the first quarter of fiscal year 2013 the Company completed a follow-on offering which contributed approximately $3.8 million of net proceeds. 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. As of March 31, 2014, the Company’s cash may not be sufficient to sustain day-to-day operations for the next 12 months.

The Company’s ability to continue as a going concern is dependent upon our ability to generate positive cash flows from our business, maintain available borrowing under our line of credit with Silicon Valley Bank, and aggressively manage our expenses, including those associated with our acquisition of the Prostiva product line from Medtronic. The Company’s ability to continue as a going concern is also dependent upon avoiding an event of default under the Note and avoiding termination of the license relating to the Prostiva product, whether by negotiation with Medtronic, cure of any non-payment giving rise to an event of default or termination, or otherwise. There is no assurance that our cash, cash generated from operations, if any, and available borrowing under our agreement with Silicon Valley Bank will 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.

There can be no assurance that the Company will be able to cure any potential event of default of the Note or cure any breach of any agreement with Medtronic, maintain compliance with its agreements with Medtronic, access available borrowings under the line of credit with SVB, raise additional capital, or improve its operating or financial performance.

The third quarter fiscal year 2014 financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result should the Company be unable to continue as a going concern.

During the nine-months ended March 31, 2014, we used $1.4 million of cash for operating activities. The net loss of $4.1 million included non-cash charges of $739,000 from the Prostiva inventory reserve, $447,000 from depreciation and amortization expense, $169,000 from stock-based compensation expense and $334,000 of accreted interest expense. Changes in operating items resulted in the generation of $1.0 million of operating cash flow for the period as a result of higher accounts payable of $387,000, lower inventories of $336,000, lower accounts receivable of $342,000 and interest payable of $245,000. These changes were partially offset by lower accrued expenses and deferred income of $187,000 and higher prepaids and other assets of $86,000.

The increase in accounts payable is the result of the timing of receipts and services versus payment. The decrease in inventories is due to lower volumes of Prostiva hand piece inventory as of March 31, 2014 due to the timing of shipments from our third-party supplier, and the decrease in accounts receivable is due to a decrease in revenue. The increase in interest payable represents the 6 percent interest accrued on the Note agreement entered into with Medtronic in June, 2013. The decrease in accrued expenses and deferred income is a result of a decrease in the commission accrual due to lower sales and lower headcount, as well as a decrease in the bonus accrual as a result of the payment of the fiscal 2013 bonuses during the first quarter of fiscal year 2014. The increase in prepaids and other assets is a result of the payment of annual insurance policies at the beginning of the fiscal year which are then amortized over the annual period.

During the nine-months ended March 31, 2014, we used $35,000 for investing activities related to the purchase of property and equipment and investments in intellectual property.

During the nine-months ended March 31, 2014, we did not generate any cash from financing activities.

We plan to continue offering customers a variety of programs for both evaluation and longer-term use of our Cooled ThermoTherapy system control units and Prostiva RF Therapy System generators and scopes in addition to purchase options. We also will continue to provide physicians and patients with efficient access to our Cooled ThermoTherapy system control units and Prostiva RF Therapy System generators and scopes on a pre-scheduled basis through our mobile service. As of March 31, 2014, our property and equipment, net, included approximately $319,000 of control units, generators and scopes used in evaluation or longer-term use programs and units used in our Company-owned mobile service.

Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements.

Recently Issued Accounting Standards

Information regarding recently issued accounting pronouncements is included in Note 15 to the condensed financial statements in this Quarterly Report on Form 10-Q.


ITEM 3.	QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK

Our financial instruments include cash and as a result 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, Gregory J. Fluet, and Chief Financial Officer, Brian J. Smrdel, have evaluated the Company’s “disclosure controls and procedures,” as defined in the Exchange Act Rule 13a-15(e), 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 Control Over Financial Reporting

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

We have been and are involved in various legal proceedings and other matters that arise in the normal course of our business, including product liability claims that are inherent in the testing, production, marketing and sale of medical devices. Based upon currently available information, we believe that the ultimate resolution of these matters will not have a material effect on our financial position, liquidity or results of operations.


ITEM 1A.	RISK FACTORS

The most significant risk factors applicable to the Company are described in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the year ended June 30, 2013, as updated by Part II, Item 1A “Risk Factors” of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 and our subsequent filings with the Securities and Exchange Commission.


ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.


ITEM 3.	DEFAULTS UPON SENIOR SECURITIES

Not applicable.


ITEM 4.	MINE SAFETY DISCLOSURES

Not applicable.


ITEM 5.	OTHER INFORMATION

None


ITEM 6.	EXHIBITS

Exhibit 31.1	Certification of Chief Executive Officer Pursuant to Section 13a-14(a) and 15d-14(a) of the Exchange Act.
Exhibit 31.2	Certification of Chief Financial Officer Pursuant to Section 13a-14(a) and 15d-14(a) 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.


		Urologix, Inc.

		(Registrant)

		/s/ Gregory J. Fluet
		Gregory J. Fluet
		Chief Executive Officer
		(Principal Executive Officer)

		/s/ Brian J. Smrdel
		Brian J. Smrdel
		Chief Financial Officer
		(Principal Financial and Accounting Officer)

		Date May 14, 2014

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. junior Avg

Urologix (ULGX) Inactive 10-Q2014 Q3 Quarterly report

Content analysis